Liberalization and Unorganized Money Markets

Liberalization and Unorganized Money Markets

An intertemporal optimizing model is used to study the welfare consequences of sequential liberalization programs in an environment where financial intermediation occurs not only in official money markets but also in unofficial(curb or grey money) markets. It is shown that raising the regulated official interest rate, which is often recommended in the financial repression literature as a measure to mobilize savings, can be welfare reducing if either trade is restricted or the fall in the unofficial interest rate caused by the reform has a very large effect on investment and future income. Similar nonstandard conclusions are shown to hold for other types of partial reforms.