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

Harold Ngalawa () and Nicola Viegi

No 201306, Working Papers from University of Pretoria, Department of Economics

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.

Keywords: Informal financial sector; formal financial sector; monetary policy; general equilibrium (search for similar items in EconPapers)
JEL-codes: E44 E47 E52 E58 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2013-01
New Economics Papers: this item is included in nep-cba, nep-dge, nep-iue, nep-mac, nep-mfd and nep-mon
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Citations: View citations in EconPapers (21)

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Related works:
Journal Article: Interaction of formal and informal financial markets in quasi-emerging market economies (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:pre:wpaper:201306

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