Financial liberation and adjustment in Chile and New Zealand

Abstract

The authors analyze macrodynamic adjustment during financial liberalization in Chile and New Zealand. During the adjustment to more open capital accounts in the late 1970s or mid-1980s, both countries experienced appreciation of the real exchange rate and a collapse of net exports, while domestic interest rates slowly converged to international levels. The authors develop and estimate a two-sector dynamic model using both current and time-varying parameters. They find the domestic interest rate to be more responsive to shocks under imperfect capital mobility, the real exchange rate more responsive under perfect capital mobility. In short, liberalization of the capital account does not eliminate volatility but rather shifts it from the domestic interest rate to the real exchange rate.Economic Theory&Research,Macroeconomic Management,Economic Stabilization,Environmental Economics&Policies,Banks&Banking Reform