Could financial liberalization ignore informal finance? a commentary

Abstract

This commentary argues that the literature as well as policy-makers could not afford to ignore the effects of financial liberalization on informal finance even if the direction of the resulting change in economic activity from liberalizing interest rates were to favor the predictions of the McKinnon-Shaw economists. The magnitude of the deviation in real as well as monetary variables from their previous levels necessitates evaluating the impact on total rather than only on formal credit activity. Policies cannot be fully effective by assuming that the relative efficiency in intermediation of the banking system neutralizes the neostructuralist critique. Unless studies address the effect on informal loan rates and activity, the length and the size of the impact of financial liberalization would remain unknown and the outcome of the policy could be destabilizing in the short-run