Financial dualism, in a cash-in-advance economy

This paper reexamines financial repression and financial dualism using an optimizing model in which demands for currency and deposits are motivated by cash-in-advance constraints. We contribute to the debate on whether financial liberalization will be expansionary, due to the interest rate stimulus to steady state capital, or contractionary, due to the effect of the higher interest rate on production costs. We find that in the presence of curb markets, neither effect is operative, and liberalization has little effect on output. Financial liberalization is likely to have significant welfare effects only when curb markets are inoperative.