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Financial Liberalization and Inflationary Dynamics in the Context of a Small Open Economy

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  • Rangan Gupta

    (University of Connecticut and University of Pretoria)

Abstract

The paper develops a short-run model of a small open financially repressed economy characterized by unorganized money markets, capital good imports, capital mobility, wage indexation, and flexible exchange rates. The analysis shows that financial liberalization, in the form of an increased rate of interest on deposits and tight monetary policy, unambiguously and unconditionally causes deflation. Moreover, the results do not depend on the degree of capital mobility and structure of wage setting. The paper recommends that a small open developing economy should deregulate interest rates and tighten monetary policy if reducing inflation is a priority. The pre-requisite for such a policy, however, requires the establishment of a flexible exchange rate regime.

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Bibliographic Info

Paper provided by University of Connecticut, Department of Economics in its series Working papers with number 2005-39.

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Length: 19 pages
Date of creation: Jul 2005
Date of revision:
Handle: RePEc:uct:uconnp:2005-39

Note: This is a revised version of a paper that was written as a part of my coursework in Monetary Theory and Policy at the University of Connecticut. I am particularly grateful to Professor Stephen M. Miller for many helpful comments.
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Web page: http://www.econ.uconn.edu/
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Keywords: Financial Liberalization; Inflation; Small open economy.;

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  1. Van Wijnbergen, S., 1985. "Macro-economic effects of changes in bank interest rates : Simulation results for South Korea," Journal of Development Economics, Elsevier, vol. 18(2-3), pages 541-554, August.
  2. Van Wijnbergen, S., 1983. "Interest rate management in LDC's," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 433-452, September.
  3. Van Wijnbergen, Sweder, 1986. "Exchange rate management and stabilization policies in developing countries," Journal of Development Economics, Elsevier, vol. 23(2), pages 227-247, October.
  4. van Wijnbergen, S., 1982. "Stagflationary effects of monetary stabilization policies : A quantitative analysis of South Korea," Journal of Development Economics, Elsevier, vol. 10(2), pages 133-169, April.
  5. Ranjanendra Narayan Nag, 2000. "Stabilization Dynamics and Non Bank Financial Intermediaries," Indian Economic Review, Department of Economics, Delhi School of Economics, vol. 35(2), pages 193-209, July.
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