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

Rangan Gupta

No 2005-39, Working papers from University of Connecticut, Department of Economics

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.

Keywords: Financial Liberalization; Inflation; Small open economy. (search for similar items in EconPapers)
JEL-codes: E31 E44 E52 F41 (search for similar items in EconPapers)
Pages: 19 pages
Date: 2005-07
New Economics Papers: this item is included in nep-cba, nep-fmk, nep-ifn, nep-mac and nep-mon
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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Working Paper: Financial Liberalization and Inflationary Dynamics in the Context of a Small Open Economy (2005)
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