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Interaction of Formal and Informal Financial Markets in Quasi-Emerging Market Economies

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  • Harold Ngalawa

    ()
    (School of Economics and Finance, University of KwaZulu-Natal)

  • Nicola Viegi

    ()
    (Department of Economics, University of Pretoria)

Abstract

The primary objective of this paper is to investigate the interaction of formal and informal financial markets and their impact on economic activity in quasi-emerging market economies. Using a four-sector dynamic stochastic general equilibrium model with asymmetric information in the formal financial sector, we come up with three fundamental findings. First, we demonstrate that formal and informal financial sector loans are complementary in the aggregate, suggesting that an increase in the use of formal financial sector credit creates additional productive capacity that requires more informal financial sector credit to maintain equilibrium. Second, it is shown that interest rates in the formal and informal financial sectors do not always change together in the same direction. We demonstrate that in some instances, interest rates in the two sectors change in diametrically opposed directions with the implication that the informal financial sector may frustrate monetary policy, the extent of which depends on the size of the informal financial sector. Thus, the larger the size of the informal financial sector the lower the likely impact of monetary policy on economic activity. Third, the model shows that the risk factor (probability of success) for both high and low risk borrowers plays an important role in determining the magnitude by which macroeconomic indicators respond to shocks.

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Bibliographic Info

Paper provided by University of Pretoria, Department of Economics in its series Working Papers with number 201306.

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Length: 27 pages
Date of creation: Jan 2013
Date of revision:
Handle: RePEc:pre:wpaper:201306

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Keywords: Informal financial sector; formal financial sector; monetary policy; general equilibrium;

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References

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Citations

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Cited by:
  1. Manoel Bittencourt & Chance Mwabutwa & Nicola Viegi, 2012. "Financial Reforms and Consumption Behaviour in Malawi," Working Papers, University of Pretoria, Department of Economics 201210, University of Pretoria, Department of Economics.
  2. Chance Mwabutwa & Manoel Bittencourt & Nicola Viegi, 2013. "Evolution of Monetary Policy Transmission Mechanism in Malawi: A TVP-VAR Approach," Working Papers, University of Pretoria, Department of Economics 201327, University of Pretoria, Department of Economics.
  3. Adnan Haider & Musleh ud Din & Ejaz Ghani, 2012. "Monetary Policy, Informality and Business Cycle Fluctuations in a Developing Economy Vulnerable to External Shocks," The Pakistan Development Review, Pakistan Institute of Development Economics, Pakistan Institute of Development Economics, vol. 51(4), pages 609-682.
  4. Chance Mwabutwa & Nicola Viegi & Manoel Bittencourt, 2012. "Monetary Policy Response to Capital Inflows in Form of Foreign Aid in Malawi," Working Papers, University of Pretoria, Department of Economics 201232, University of Pretoria, Department of Economics.
  5. Nicoletta Batini & Paul Levine & Emanuela Lotti & Bo Yang, 2011. "Informality, Frictions and Monetary Policy," School of Economics Discussion Papers, School of Economics, University of Surrey 0711, School of Economics, University of Surrey.
  6. Duo Qin & Zhong Xu & Xue-Chun Zhang, 2013. "How Much Has Private Credit Lending Reacted to Monetary Policy in China? The Case of Wenzhou," Working Papers, Department of Economics, SOAS, University of London, UK 178, Department of Economics, SOAS, University of London, UK.

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