In this paper, the relationship between aggregate household saving and the rates of interest offered under a dual financial system is examined. The basic notion is that, given consumer credit is limited in the regulated financial institutions, an adjustment of the portfolio of the savers associated with a change in the interest rates will affect the ability of dissavers to borrow from the black market to finance their consumption.
Specifically, loanable funds are siphoned off from the black market to the regulated financial institutions when the rates of interest offered by the regulated financial institutions increase or when interest rates on the black market decrease. As a result, consumers who resort to the black market will be constrained to an even greater extent. In as much as the marginal propensity to consume of the constrained consumer is usually larger than that of the unconstrained consumer, it is hypothesized in the paper that aggregate household saving tends to change in line with changes in the interest rates of the regulated financial institutions. In contrast, an increase in the black market interest rates should result in lower aggregate household savings.
The yearly data for Taiwan during the period 1954–1981 supports the above proposition. The evidence suggests that interest rates along with the availability of consumer credit are important determinants of household saving in Taiwan, and, by extension, in those developing countries characterized by a dual financial system.
