Financial Repression in a Natural Experiment: Loan Allocation and the Change in the Usury Laws in 1714

Abstract

If in general, financial deepening aids economic growth, then financial repression should be harmful. We use a natural experiment - the change in the English usury laws in 1714 - to analyse the effects of interest rate restrictions. Based on a sample of individual loan transactions, we demonstrate how the reduction of the legal maximum rate of interest affected the supply and demand for credit. Average loan size and minimum loan size increased strongly, and access to credit worsened for those with little 'social capital'. While we have no direct evidence that loans were misallocated, the discontinuity in loan receipts makes this highly likely. We conclude that financial repression can undermine the positive effects of financial deepening; Britain's disappointing growth during the period 1750-1850 may partly reflect the effects of harmful credit market regulation.

Keywords: Economic development, banking, financial repression, usury laws, credit rationing, natural experiments, lending decisions

JEL Classification: G21, N23, O16