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Ronald McKinnon, 1935 - 2014

2014-10-02 11:41:22

Ronald McKinnon has died

Oct 1st 2014, 22:10 by G.I. | WASHINGTON, D.C.

Ronald McKinnon, a prolific and pioneering international economist, died today

of complications from a fall he suffered at San Francisco's airport 12 days

ago. The news come from John Shoven at Stanford University, where Mr McKinnon

had been a professor since 1961.

McKinnon wrote extensively over his career about exchange rates, finance,

economic development and monetary systems. But he was best known for developing

the theory of "financial repression" along with his mentor, Edward Shaw, in the

early 1970s. Originally aimed at explaining disparities in economic

development, the term has come back in vogue in recent years to describe many

of the policy responses to the financial crisis and ensuing recession.

In the early 1970s, development economists thought that a lack of capital was

the primary impediment to economic development, and development strategies were

heavily premised on boosting the capital stock through government financed

investment and foreign aid. Mr McKinnon instead focused on the maturity of the

domestic financial system. In many countries, banks were forced to hold

extensive reserves (often in government bonds), cap the interest rates paid on

deposits or charged on loans, or direct credit to favored sectors. Sometimes,

this was meant to help particular parts of the economy. Often, it was simply a

way to make it easier for the government to fund its budget deficit, by in

effect forcing banks to lend to it, at below-market interest rates. Mr

McKinnon, and Mr Shaw, writing in 1973, called this "financial repression." Mr

McKinnon argued this severely stunted economic growth. It resulted in negative

real interest rates which discouraged people from holding deposits and thus

impaired the ability of the banking system to lend. Entrepreneurs were forced

to self-finance, but negative real interest rates made it difficult to

accumulate the necessary savings. Financial repression fragemented the economy

with some sectors or businesses paying much higher interest rates than others,

making investment unattractive or inefficient.

Underdeveloped financial systems, he argued, often played a role in crises.

Banks are unable to act as "efficient information conduits between depositors

and borrowers". Economic reforms, including financial liberalization, may

create undue optimism about a country's prospects and a surge of capital

inflows which become unsustainable, resulting in a crisis.

Many of the steps taken to safeguard the world from a global financial crisis

involve forcing banks to hold more reserves or to penalise them for holding

assets other than government bonds, implicitly encouraging them to lend to the

government. Global finance has fragmented as regulators seek to wall their

financial systems off from foreign contagion. Carmen Reinhart in particular has

characterised this as a new form of financial repression.

Mr McKinnon in recent years dwelt heavily on the role of the dollar in the

world financial system. In America, he took aim at the Federal Reserve's

policies of zero interest rates and quantitative easing. Here, his

prescriptions were less successful. He had diagnosed the evils of negative real

interest rates at a time when they were used as a policy tool independent of

monetary considerations. He thought that in America, they would lead to

inflation, distortions in the banking system, and reduced lending, and he

argued for higher rates. In fact, inflation never took off, and bank lending

was held back not by the unprofitability of loans but the lack of demand and

regulatory constraints. In the last year, loan demand has recovered along with

the economy.

Nonetheless, Mr McKinnon made huge contributions to economics, in particular

the insidious ways government-induced distortions in the financial markets,

often with the best of intentions, can hurt economic growth in the long run.