Trade and Domestic Financial Market Reform Under Political Uncertainty: Implications for Investment, Savings, and the Real Exchange Rate
IMF Working Papers, October 1, 2000
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- Trade and Domestic Financial Market Reform Under Political Uncertainty: Implications for Investment, Savings, and the Real Exchange Rate
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Bibliographic details
- Authors: Rina Bhattacharya
- Published: October 1, 2000
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781451858747.001
Summary and main findings
- The paper presents a model that incorporates uncertainty about trade reform and analyzes the effects of trade and financial liberalization on domestic investment and savings, the current account balance and the real exchange rate, both when the capital account is open and when it is closed.
- Under certain assumptions financial liberalization leads to a movement of resources in the opposite direction to that implied by trade liberalization and to real exchange rate appreciation, thus defeating one of the objectives of tariff reform, when the capital account is open.
- When political economy linkages are taken into account, however, the indirect effects of financial liberalization may offset the direct effects, encouraging a movement of resources in the desired direction.
- With a closed capital account these results should still hold unless there are strong negative income effects from trade reform.
Model, assumptions, and mechanisms analyzed
- Incorporates uncertainty about trade reform.
- Compares outcomes under an open capital account and a closed capital account.
- Examines interactions between:
- trade liberalization (tariff reform),
- domestic financial liberalization (financial market reform),
- political economy linkages,
- movements of resources (investment and savings),
- the current account balance, and
- the real exchange rate.
Policy implications and interpretation
- Financial liberalization can counteract the intended resource reallocation from trade liberalization and can lead to real exchange rate appreciation when the capital account is open, potentially undermining tariff reform objectives.
- Accounting for political economy linkages can change the net effect of financial liberalization, as indirect effects may offset direct effects and restore movement of resources in the desired direction.
- With a closed capital account, the qualitative conclusions generally remain, except where trade reform generates strong negative income effects that alter outcomes.