Liberalization in general can be defined as the act in which something is made less strict. Financial Liberalization therefore refers to the reduction in any type of regulations in the financial industry of any given country (Hermes & Lensink, 2005). It is the lessening of restrictions on different types of the lending instruments which can be traded and lending institutions. Examples of lending institutions that are affected by the financial liberations are the banks, money market funds, investment banks, county’s treasury or any individual issuing bonds, hedge funds and others. Financial liberation leads to the breaking away or avoiding the state of the economy being financial repression which is commonly related to government being involved in fixing interest rates which has adverse consequences in a countries economy based on the financial sector. Financial liberation is therefore related to the freeing of lending institutions interest rates as well as elimination in different restrictions in the financial sector including the removal of the restrictions in banking sector, restrictions as well as managed changes in the monetary policy institutional framework, and even in the reform of different external sectors.
This paper therefore assesses how financial liberation usually affects economies taking United Kingdom as our case study. It provides theoretical evidence on the merits and demerits of financial liberation in UK economy and how it spurs growth in productivity as well as marginally effects on the economy capital accumulation.
The failure of some of the consumption models in predicting reasons for the fall in UK savings ratio during the late 1980s as well as in rise of the saving ratios in the early 1990s motivated economists to draw some of the US studies so as for other different models which would have been better for different consumers in UK that were unable to borrow. This, together with increased competitive lending markets led to financial liberation in UK where restrictions were eased for borrowers (ShehzaZ & De Haan, 2008). UK is now known to have a liberalized system with many people blaming the current financial crisis due to liberalization. People view financial liberalization as having allowed risky financial instruments to be created and the interest rates restrictions which creates different more problems leading to recession. Examples of this include the increase in credit, increased number of loans that are risky, as well as different many bubbles. However, despite this, financial liberation affects the economy productivity both positively and negatively as well as directly and indirectly in growth rates and capital accumulation.
After the worst economic and financial crisis like three years before, the UK economy as well as the financial sector has in some ways stabilized due to financial liberalization and notably through ensuring that reform regulatory practices and policies are momentary maintained. This has been through the FSA which has played a major role in this important endeavor. For instance, the UK proposals for the new structure of financial regulation in 2010 that mainly remedies the failures in the already existing financial regulatory system and especially of the bank of England, the FSA, i.e. the Financial Service Authority as well as the Treasury are deemed to be collectively liable for the UK economic and financial stability. The new approach maintained in this structure to mostly partake supervision such as yearly stress tests in all UK financial institutions will reform them to better performance (Ucer). This will not only crystallized consumer risks but will also take care of consumers detriments. However, some significant demerits involves the inability is spotting and preventing some of the major risks from crystallization hence resulting in damaging consumers as well as market confidence and in the end harming consumers (Ross, 1997.
One major argument is that financial liberation usually allows UK markets in determining interest rates which on the other hand stimulates savings as well as investments in the economy. This therefore gives rise to the economy’s virtuous cycle of growth and household’s savings. Through investments, major projects can be undertaken in the economy that leads to further growth and individual enhancements. UK as a liberalized system usually ensures that the financial system have a cyclical effects on the financial interest rates. However, deregulation in the economy has some adverse effects and especially on household saving although in the short-term (Maria & Williams, 1999).
On the other hand, financial liberation affects the economy productivity directly when it is expected to create international competition for different funds, thus forcing capital towards on different projects that are most productive. Indirect effects are seen when financial liberation fosters developments financially which on the other hand affects the economy’s productivity. Through increased competition, internationally, capital accumulation as an effect of direct financial liberation is usually ambiguous. For instance, liberation leads to openness of different capital stocks where capital reallocation on the other hand translates to different net flows in the country. As an indirect effect, financial development is defined as weak thus triggering the financial instability in UK’s economy as well as causing banking crises (Maria & Williams, 1999).. Banking crises are risky as they harm the capability of any financial system of any economy in providing credit to the economy; therefore, these results to slow down in the investments in both physical capital as well as innovation investments. This may also lead to worst effect of dropping down of the TFP as a major need to shut down some productive projects.
Another important example of implication of financial liberalization in the economy is that it causes the relaxation in not only the consumption but also in causing liquidity constrains in the economy where savings precautionary are deemed to decrease. This therefore has the meaning that consumers are forced in holding low buffer-stock savings which leaves them very much exposed to the economy shocks. Reduction in the precautionary savings by individuals in turn results to consumers increasing in their aggregate consumption.
The case of UK behavior in consumption particularly the savings ratio is one major example of the effects of the financial liberalization in UK. During the 1990s, UK financial sector was under heavy influence by broad deregulation of financial services and industries which led to long-run stable relationships for consumption function in U.K in shifting significantly. Financial liberalization influences consumption through the behavior that exists in two different groups of consumers (Barrell & Davis, 2000). This include the consumers who are constrained in consuming only from their current income as well as those consumers who relies on borrowing mainly basing on the income inflows from the expectation of the future income flows. Financial liberation therefore affects the behavior of the consumers by shifting in their saving ratios. It also causes monetary policy transmission which alters in different significant ways leading implications in ways in which UK monetary policy are implemented.
For instance, financial liberalization is said to have the effect in which it strengthens the authority of finance over the UK State. The Bank of England autonomy usually removes different policies that are very imperative to UK’s economy such as, monetary policy, credit policy, and exchange rate policy from the government and hence trust such policies to the whims of different financiers, or even to a bunch of bureaucrats who on the other hand exercises control over the sovereign Central Bank (Sants, 2010). This therefore restricts the realm of intervention of UK. Additionally, since State borrowing from Bank of England is fixed, the autonomous Bank will simply push the State the financial market meeting it their requirements for borrowing above this limit….Hence, UK state will only spends in limit to what it has been allowed by finance capital. This, in Finance capital’s eyes then becomes creditworthy and a matter of supreme importance to the State and it is drove to pursue policies that are only allowed by finance capital for the benefit of the economy.
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