Crash-Free Sequencing Strategies for Financial Development and Liberalization

Abstract

This paper uses a stylized model of financial intermediation to characterize the exact circumstances along various paths of economic growth, financial development, and liberalization that can trigger a financial crisis. It shows how to avoid financial crises through proper sequencing of various financial development and liberalization measures. The results of the paper show that naive combinations of financial development and liberalization processes can give rise to financial crises. In some typical situations, in order to avoid a financial crisis, it is important that financial liberalization be accompanied by financial development, in the form of improvements in the financial sectorís efficiencies. In the case of fast growing economies, financial development becomes even more imperative. Copyright 2001, International Monetary Fund