An Analytical Approach to Interest Rate Determination in Developing Countries

The role of interest rates in the development process has been studied exten· sively in recent years. Following upon the seminal work of McKinnon (1973), there have been a number of theoretical and empirical studies examining the relationship between financial development and economic growth, the effect of changes in real interest rates on savings and investment, and more generally, the pros and cons of a market-oriented financial system.1 Broadly speaking, there is now ample empirical evidence supporting the original claim by McKinnon [10] that there is a positive association between the degree of development of the financial sector, resulting primarily from a freer structure of interest rates, and the overall economic performance of developing countries.