The recent literature on finance and development has generally concluded that financial intermediation improves the allocation of credit to firms for investment, and hence raises the rate of return on capital and growth. In Discussion Paper No. 662, Research Affiliate Tullio Jappelli and Research Fellow Marco Pagano develop an overlapping generations model to focus on credit to households: the young borrow to finance current consumption, the middle-aged repay their loans and save for retirement, and the old consume these accumulated savings. With exogenous productivity growth, liquidity constraints raise the saving rate, and growth has a stronger effect on savings as the severity of liquidity constraints increases. Jappelli and Pagano show that these propositions hold in the steady state and in the transition between steady states, and in both the closed economy and in a small open economy with perfect capital mobility. With endogenous productivity growth, increases in savings due to liquidity constraints raise the growth of the capital stock and output.

Jappelli and Pagano then test these propositions on three recent sets of cross-country data, using the ratio of consumer credit to national income and the maximum loan-to-value ratio for conventional mortgage loans as proxies for the degree of development of the market for household credit. They find that liquidity constraints are indeed positively correlated with national savings and the growth rate. In addition, the effect of growth on saving is smaller in countries offering households relatively easy access to credit Scandinavia, the UK and US than in those where credit is more tightly rationed Greece, Italy and Spain. On average, liquidity constraints account for almost one-quarter of national savings and one-third of the growth rate of the sample countries.

Jappelli and Pagano use these results to estimate the impact of financial deregulation on national savings rates in the last three decades. Deregulation of mortgage markets in the OECD area explains about 10% of the decline in national savings in the 1980s, but this effect is strongly concentrated in the handful of countries that deregulated their mortgage markets: Denmark, Spain and the UK. Financial liberalization in the European Community is therefore likely to reduce further the savings and growth rates of those countries in which households' access to credit is currently limited, such as Greece, Italy and Portugal, leading to a further reduction in overall EC savings and growth, other things being equal.

Saving, Growth and Liquidity Constraints
Tullio Jappelli and Marco Pagano

Discussion Paper No. 662, May 1992 (IM)