Interest rates, saving, investment and growth in mexico 1960–90: Tests of the financial liberalisation hypothesis

Abstract

The theory of financial liberalisation argues that rising real interest rates induces more saving and investment and therefore acts as a positive stimulus to economic growth. This hypothesis is tested for Mexico over the period 1960–90, making the important distinction between financial saving and total saving. Financial saving is found to be positively related to real interest rates partly through capital flows and partly through domestic asset substitution, but total saving is invariant with respect to real interest rates. Investment is positively related to the supply of credit from the banking system, but the net effect of interest rates on investment is negative. Furthermore, taking McKinnon's ‘virtuous circle’ model of economic growth shows no favourable effects of interest rates on economic growth. It is concluded that any favourable effect of financial liberalisation and higher real interest rates on economic growth must come through raising the productivity of investment.