Financial liberalization and inflation dynamics: some evidence from Zambia

Christopher S. Adam

No 1994-14, CSAE Working Paper Series from Centre for the Study of African Economies, University of Oxford

Abstract: Reforms which include liberalization of the foreign exchange system and domestic asset markets impose direct fiscal costs on governments which are net purchasers of foreign currency from the rest of the economy and net borrowers from the domestic financial system. However if the liberalization measures also induce private agents to reduce their holdings of domestic money in favour of foreign currency or other interest bearing domestic assets, equilibrium seigniorage for any rate of money supply growth will also fall, exacerbating the direct fiscal costs of liberalization. This paper presents an adaptive expectations model of the response to financial liberalization applied to Zambia. A number of countries, including Zambia, have responded to incipient hyperinflationary pressures by instituting cash-budget provisions which enforce a zero rate of growth of base money. This produces a rapid reduction in inflation expectations and a period of negative actual inflation, but at the cost forgoing seigniorage revenue altogether. The cash-budget is shown to be inferior to higher inflation equilibria available to the government.

JEL-codes: E31 E41 O23 (search for similar items in EconPapers)
Date: 1994
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Published in World Development, Vol 23, 1995

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