RESEARCH PAPER NO. 835

USING A 2-SECTOR GROWTH MODEL TO ASSESS THE MACROECONOMIC CONSEQUENCES OF FINANCIAL LIBERALIZATION

by

YUAN K. CHOU & MARTIN S. CHIN

JANUARY 2002

Department of Economics. University of Melbourne. Melbourne Victoria 3010 Australia

ABSTRACT

This paper uses the economic growth model with a financial sector developed in Chou and Chin (2001) to examine the conditions under which financial liberalization is desirable from the perspective of a policymaker who is concerned about the well-being of domestic households. Financial liberalization raises the rate of financial innovations and the efficiency of financial intermediation, but typically causes large foreign firms from leading-edge countries to displace smaller and less efficient domestic firms. Profits are repatriated abroad instead of accruing to domestic households as dividends. This trade-off is further complicated when we allow financial firms to hire talented foreigners once liberalization has taken place.

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