Interest-Rate Liberalization and Capital Misallocations


Pengfei Wang

Zhiwei Xu

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2017-15 | January 1, 2020

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, interest-rate liberalization can improve capital allocations within each sector, but can also exacerbate misallocations across sectors. Under calibrated parameters, the liberalization policy can 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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Article Citation

Wang, Pengfei, Zheng Liu, and Zhiwei Xu. 2017. “Interest-Rate Liberalization and Capital Misallocations,” Federal Reserve Bank of San Francisco Working Paper 2017-15. Available at

About the Author
Zheng Liu
Zheng Liu is a vice president and director of the Center for Pacific Basin Studies in the Economic Research Department of the Federal Reserve Bank of San Francisco. Learn more about Zheng Liu