Financial Liberalization with Productive Public Expenditure and A Curb Market
This paper develops a monetary endogenous growth model of a financially repressed economy, characterized by an Unofficial Financial Market and productive public expenditure, and, in turn, analyzes the effects of financial liberalization on the rate of growth and inflation. Following the current trend in the literature the size of obligatory cash reserve requirement held by the official financial intermediaries is used as the metric for financial repression. Results indicate that financial liberalization, or in other words, lowering of the reserve requirement, is inflationary and growth-reducing. From a policy perspective, the analysis suggest that in an economy characterized by productive public expenditure, if the government ends up repressing the financial sector to a degree where curb market emerges, financial liberalization is not the desired choice of policy and, hence, policy makers should proceed with caution if low inflation and high growth are the major objectives.
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