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Federal Reserve Bank of San Francisco
Working Paper Series
Interest-Rate Liberalization and Capital Misallocations
Zheng Liu
Pengfei Wang
Zhiwei Xu

We study the consequences of interest-rate liberalization in a two-sector general equilibrium model of China. The model captures a key feature of China's distorted financial system: state-owned enterprises (SOEs) have greater incentive to expand production and easier access to credit than private firms. In this second-best environment, liberalizing interest rate controls improves capital allocations within each sector, but exacerbates misallocations across sectors. Under calibrated parameters, interest-rate liberalization may reduce aggregate productivity and welfare, unless other policy reforms are also implemented to alleviate SOEs' distorted incentives or improve private firms' credit access.

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Zheng Liu & Pengfei Wang & Zhiwei Xu, Interest-Rate Liberalization and Capital Misallocations, Federal Reserve Bank of San Francisco, Working Paper Series 2017-15, 01 May 2017.
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Note: Date of publication: May 2017.
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DOI: 10.24148/wp2017-15
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