n South African Journal of Economic and Management Sciences - Rational expectations and the effects of financial liberalization of price level and output : economics
|Article Title||Rational expectations and the effects of financial liberalization of price level and output : economics|
|© Publisher:||University of Pretoria|
|Journal||South African Journal of Economic and Management Sciences|
|Publication Date||Mar 2007|
|Pages||107 - 115|
|Keyword(s)||E31, E44, E52 and F41|
ISI Social Science
This paper develops a generalized short-term model of a small open financially repressed economy, characterized by unorganized money markets, intermediate goods imports, capital mobility, flexible exchange rates and rational expectations, to analyze the price- and output-effects of financial liberalization. The analysis shows that financial deregulation, in the form of increased rate of interest on deposits and higher cash reserve requirements, unambiguously and unconditionally reduces domestic price level, but fails to affect output. Moreover, the result does not depend on the degree of capital mobility. The paper recommends that a small open developing economy should deregulate interest rates and tighten monetary policy if reducing inflation is a priority. Such a policy, however, requires the establishment of a flexible exchange rate regime.
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