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The Puzzle of Persistently Negative Interest Rate-Growth Differentials: Financial Repression or Income Catch-Up?

The data on profitability start with an important finding: earning profits does not imply being a “for-profit” bank. Most microfinance institutions in our sample that have total revenues exceeding total costs in fact have “non-profit” status. They are earning profits in an accounting sense, but as non-profits they cannot distribute those profits to investors. The distinction is important, as it means that the microfinance industry’s drive toward profitability does not necessarily imply a drive toward “commercialization,” where the latter status reflects institutions that operate as legal for-profit entities with the possibility of profit-sharing by investors. If. | The Puzzle of Persistently Negative Interest Rate-Growth Differentials Financial Repression or Income Catch-Up Julio Escolano Anna Shabunina and Jaejoon Woo INTERNATIONAL MONETARY FUND 2011 International Monetary Fund WP 11 260 IMF Working Paper Fiscal Affairs Department The Puzzle of Persistently Negative Interest Rate-Growth Differentials Financial Repression or Income Catch-Up 1 Prepared by Julio Escolano Anna Shabunina and Jaejoon Woo November 2011 This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author s and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author s and are published to elicit comments and to further debate. Abstract The interest rate-growth differential IRGD shows a marked correlation with GDP per capita. It has been on average around one percentage point for large advanced economies during 1999-2008 but below -7 percentage points among non-advanced economies exerting a powerful stabilizing influence on government debt ratios. We show that large negative IRGDs are largely due to real interest rates well below market equilibrium possibly stemming from financial repression and captive and distorted markets whereas the income catch-up process plays a relatively modest role. We find econometric support for this conjecture. Therefore the IRGD in non-advanced economies is likely to rise with financial integration and market development well before their GDP per capita converges to advanced-economy levels. JEL Classification Numbers E31 E4 E6 G1 H6 O47 Keywords interest rate-growth differential real interest rates debt dynamics dynamic efficiency income catchup financial repression financial integration. Author s E-Mail Address iescolano@imf.org ashabunina@imf.org iwoo@imf.org 1 The authors would like to thank Carlo Cottarelli Olivier Blanchard Phil Gerson Manmohan Kumar Rodrigo Valdes Gian Maria .