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Liberalization of trade in financial services is good (or not) for economic growth in developing countries.

without comments

Bellow, I provide arguments to oppose the liberalization proposition.

As provided in 4a, the argumentation confronting the liberalization in financial service is basically based on the doubt that financial repressions by central bank over financial institutions is really exist. Just to repeat the argument, for instance, the worry that the financial repression will weaken the saving propensity of the people and therefore also weaken transferability of saving into investment but in fact, the demand for investment is not depend on the availability of accumulated saved money since there are always a central bank who can back up the commercial bank in the case of the excessive investment demand. The other argument is that the liberalization through high rate of interest in order to make saving attractive can have a boomerang effect on investment, when investor loosing their mood to invest even though the money have been accumulated through saving simply because the high rate of interest.

The other argument is something related to the situation in developing country itself. Since developing country need investment project to develop and since that investment project need a more stable and steady supply of money which is cannot be satisfied if the financial sector is being liberalized. In the deregulated financial sector, an investment agent is always has a full freedom to move their capital from one financial institution to another institution as they wish without any investment purposive regulation. In this way the availability of private saving is always in the form of “hot” money that can easy to come and easy to go.  This fast moving money is becoming faster in term of transaction by the aid of information and communication technology. Meanwhile, an to be successful an investment project need several condition that most of it need a long lasting commitment to invest since it happening in the real economy. Because, in turn, the investment project in developing country could also highly affects the real macroeconomic indicators such as income and unemployment which is hard if the money market is liberalized.

Written by ibu didin

February 13th, 2010 at 1:06 pm

Relation between Economic Growth and Inflation

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What is the theory and empirical evidence on the relationship between economic growth and inflation.

Economic growth and inflation are both positively correlated. This means that inflation is one of the inherent economic growth’s features. Along.  Hamilton (1952) claimed that inflation is an important stimulant for creating growth and Rostow (1960) also argued that inflation is necessary for developing industrial take-offs. The great support of inflationary policy is came from Keynes, compare to deflation Keynes is more tolerable to inflation he described both of inflation and deflation in negative term one is unjust and the other is inexpedient, but to have inflation is preferable because to provoke unemployment is worse than to disappoint the rentier.

Keynes argued that investment can generate its own saving by raising the level of income when the economy is not performed, and inflationary policy can redistribute income from wage earners with low propensity to save to profit earner with high propensity to save when economy perform at full capacity. The second argument of Keynes is, the inflation can encourage investment by raising the nominal rate of return on investment and reduce the real rate of interest.

However, there are some dangers of inflation that need to be considered. Just to mention one of them is that inflation can reduce the purchasing power of money if it is reaching excessive level. And it can put the society in a real resource costs and welfare losses.

Numbers of empirical studies show that inflation has a non-linier relationship with growth. Bruno (1995), at World Bank, who observe annually on 127 countries over the year 1960-1992 shows that inflation and growth are positively related up to 5 per cent inflation and then start to declining to inflation set. And it comes to negative relationship when the inflation rate reaching 30 per cent. The other study by Sarel (1996) at the IMF shows the similar result when he examined 87 countries over the period 1970-1990 and divide the observation into twelve inflation group using inflation of group 6 as reference show that in the inflation take a positive effect on growth for group 7 (averagely 8%) and start toward negative relationship when inflation is very high. The evidence of non-linearity and growth is also found by Stanners (1993) he studied 9 countries over the period of 1948-1986 and 44 countries over 1980-1988 that after divide the 44 countries into four groups the growth is highest for the second group.

The lesson from empirical data is, it is okay to have inflation an moderate level since it is an inherent feature of growth but what is need to be aware is when inflation rate reaches an excessive level which could create hyperinflation.

Written by ibu didin

February 13th, 2010 at 1:04 pm