Publication Date

1996

Abstract

During the 1980s, Australia moved from having one of the most heavily controlled banking and financial sectors to having one of the least controlled. The reasons for such an extensive and swift change in the operation of the financial sector are discussed, as well as the implications for the operation of monetary policy. These developments have had major implications for the way in which exogenous disturbances are transmitted to the macroeconomy, affecting financial variables immediately and, over a more prolonged period, non-financial variables. Considerable debate has taken place in Australia as to the beneficial consequences of such extensive deregulation for that economy, which is characterised as being very open but small by world standards. As a contribution to this debate the paper presents a theoretical macroeconomic framework applicable to such a small open economy, focusing upon the importance and role of the financial sector in the transmission of exogenous shocks to the macroeconomy. Two versions of the model are presented: that where the financial sector is heavily regulated (pre-1983 in Australia) and that where it is deregulated (post 1983). Comparisons are made between the adjustment of the macroeconomy for each of these versions, for a variety of exogenous shocks using a numerical simulation procedure. The results derived suggest that in general macroeconomic adjustment tends to be less turbulent, and steady-state equilibrium achieved more rapidly, with a deregulated financial sector, lending support to the viewpoint that such a policy has assisted the economy in adjusting to the turbulent developments of the 1980s and early 1990s.

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