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Fiscal, Monetary, and Reserve Requirement Policy in an Endogenous Growth with Financial Market Imperfections

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  • Fu-Sheng Hung

    (Department of Economics, National Chung Cheng University)

Abstract

A simple endogenous growth model is developed in a framework where informational imperfections in financial markets give rise to adverse selection as well as costly state verification problems and the government needs to intervene financial markets to monetize its deficits. In the model, adverse selection problem raises credit rationing and financial intermediaries arise endogenously due to costly state verification. Inflation is shown to influence the amount of credit rationing and economic growth. We then examine the effects of government fiscal and monetary policies on equilibrium inflation, the amount of credit rationing, and thus economic growth. Results show that multiple equilibria arise when the share of government deficits is relatively large. We also illustrate how the use of reserve requirement policy can eliminate high inflation equilibrium and enable the government to reduce the inflation rate. In sum, it is found that Tobin effect hold when there is no reserve requirement or it is not binding. However, if the reserve requirement is set too high, such a policy will raise the equilibrium inflation rate and reduce economic growth, leading to a violation of Tobin effect.

Suggested Citation

  • Fu-Sheng Hung, 2001. "Fiscal, Monetary, and Reserve Requirement Policy in an Endogenous Growth with Financial Market Imperfections," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, vol. 26(1), pages 61-82, June.
  • Handle: RePEc:jed:journl:v:26:y:2001:i:1:p:61-82
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    References listed on IDEAS

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    1. Bose, Niloy & Cothren, Richard, 1996. "Equilibrium loan contracts and endogenous growth in the presence of asymmetric information," Journal of Monetary Economics, Elsevier, vol. 38(2), pages 363-376, October.
    2. Williamson, Stephen D., 1986. "Costly monitoring, financial intermediation, and equilibrium credit rationing," Journal of Monetary Economics, Elsevier, vol. 18(2), pages 159-179, September.
    3. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
    4. Nichols, Donald A, 1974. "Some Principles of Inflationary Finance," Journal of Political Economy, University of Chicago Press, vol. 82(2), pages 423-430, Part I, M.
    5. Di Giorgio, Giorgio, 1999. "Financial development and reserve requirements," Journal of Banking & Finance, Elsevier, vol. 23(7), pages 1031-1041, July.
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    Cited by:

    1. Rangan Gupta, 2005. "Costly State Monitoring and Reserve Requirements," Annals of Economics and Finance, Society for AEF, vol. 6(2), pages 263-288, November.

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