Financial Repression and Financial Liberalization in a Small Open Economy: A Cash-in-Advance Approach

Hong-Bum Kim ; Betty C. Daniel

Professor, Department of Economics, Gyeongsang National University, Seoul, 660-701, Korea, Tel: +82-55-751-5747 hbkim@nongae.gsnu.ac.kr
Professor, Department of Economics, State University of New York at Albany, Albany, New York 12222, U.S.A., Tel: +1-518-442-4747 bd892@cnsunix.albany.edu

JEL Classification: D90, E44, N10

Abstract

It is widely believed that fragile domestic banks, together with their huge intermediation of foreign capital, contributed to outbreak and propagation of the 1997 Asian economic crisis. Notably, the crisis countries were those that had recently replaced their old regime of financial repression with a new regime of financial liberalization. This paper reexamines financial repression and liberalization using a cash-in-advance model, which explicitly considers capital accumulation in a small open economy. We derive and discuss the steady state in each regime. Further, we demonstrate that an economy is structurally more vulnerable to a negative real shock when it is financially liberalized than when repressed. Policy implication of this finding is also discussed.

Keywords:

Financial repression, Financial liberalization, Cash-in-advance, Small open economy

Acknowledgments

An earlier version of this paper was written during the first author's visit at the SUNY Albany, USA, and was presented at a seminar of the Business and Economics Research Institute, Gyeonsang National University, Korea, and at the 1999 Annual Conferences of the Korea Money and Finance Association and the Korean National Economic Association. The first author thanks Dr. Hag-Soo Kim, the seminar participants, and the two anonymous referees of this Journal for their comments. He also gratefully acknowledges the financial support from the Yonam Research Foundation, Korea.

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