Pierre-Richard Agénor
Informal Financial Markets in Developing Countries
by Peter J. Montiel, Pierre-Richard Agénor and Nadeem Ul Haque
Book Online
Chapter 1: Nature and Scope of Informal Financial Markets
Chapter 2: Models of Informal Financial Markets
Chapter 3: Macroeconomic Policy with Informal Financial Markets,An Integrated Framework
Chapter 4: A General Equilibrium Model with Informal Finacial Markets
Chapter 5: Policy Issues and Model Simulations
Epilogue, Appendices, References, Index of Names, Subjects
Review by Sonja Ruehl, The Economic Journal, Vol. 104, Issue 426 (September, 1994). Pg. 1245.
"This book is the product of research on informal financial markets conducted mostly within the Research Department of the IMF. Its aim is the ambitious one of showing how to include informal loan and foreign exchange markets in macroeconomic analysis and policy design. First comes the author's general model of financial markets in small, open economies based on a 'portfolio balance' approach. They use this to illustrate the transmission mechanisms of macroeconomic policy in developing countries and conclude that informal loan and foreign exchange markets play an important role in transmitting the effects of financial policy instruments to aggregate demand, through some unconventional channels. What is unusual in the elaboration of a general equilibrium model integrating informal financial markets as a central feature, which the authors are then able to use to simulate the effects of macroeconomic shocks - an increase in government spending, an increase in central bank credit to commercial banks, liberalization of official bank lending rates, and an official exchange rate devaluation. This is an unusual addition to the mostly microeconomic literature on informal markets and a serious attempt to integrate the special features of developing economies into mainstream macroeconomic analysis."
Review by Victor Murinde, The World Economy, Vol. 18, Issue 1 (January, 1995). Pgs 161-2.
"Economists have recently become interested in the informal sector in developing countries (LDCs). In particular, policy makers and academics are beginning to appreciate the central role played by informal financial markets in oiling the wheels of production, trade and consumption in these economies. For example, many LDCs have experienced bank credit rationing mainly due to financial repression characterized by regulated interest rates and high required reserve rations. In addition, foreign exchange rationing has been a common phenomenon owing to the existence of trade controls and restrictions on foreign exchange transactions. As such, informal credit markets and parallel foreign exchange markets have served to fill and important gap for domestic and international finance, respectively. However, the literature indicates that these aspects have been studies largely in isolation, rather than in a unified macroeconomic model. The main contribution of Informal Financial Markets in Developing Countries to the existing literature is that it brings into a unified macroeconomic framework the key aspects of informal credit and foreign exchange markets.
The book comprises six well-linked chapters, two useful theoretical and empirical appendices, helpful references, and an author as well as a subject index. Chapter 1 sets the scene for the book by reviewing the nature and scope of informal financial markets, as well as the main controversial issues like the definition and size of informal credit markets, and the supply and demand for foreign exchange in the parallel currency markets. The main analytical macroeconomic models which have been separately developed to underpin informal financial markets are reviewed in Chapter 2. As regards bank credit markets, the McKinnon-Shaw models as well as the neo-structuralist models are examined; however, there is limited reference to the wealth of empirical evidence generated by the extension of these models. As regards informal currency markets, the main vintages of models for parallel currency markets are excellently discussed, the real trade model, the monetary approach, and the dual exchange rate model in particular. Once again, however, the authors missed the opportunity to bring out the available evidence to discriminate between these competing models.
Key elements of informal credit markets and parallel foreign exchange markets are brought together into a unified macroeconomic framework in Chapter 3; it is shown that these markets determine the effects of macroeconomic policies. This is an important result, especially when the lack of a unified theoretical framework seriously undermines the policy prescriptions being generated for many LDCs, especially Sub-Saharan Africa. For example, Finn Tarp's Stabilization and Structural Adjustment: Macroeconomic Frameworks for Analyzing the Crisis in sub-Saharan Africa (London and New York, 1993) finds that the 'African alternative framework to structural adjustment programmes for recovery and transformation' proposed by the UN Economic Commission for Africa lacks theoretical rigour compared to the 'Financial Programming Model' of the IMF and the 'Revised Minimum Standard Model' of the World Bank.
The unified framework is extended, in Chapter 4, into a detailed general equilibrium model. One other significant innovation is the incorporation into the analysis of novel features like imported intermediate inputs and linkages between the formal and informal sectors, as well as some stylized macroeconomic issues such as the existence of nominal wage contacts, and forward-looking and perfect-foresight agents. In Chapter 5, the model is solved using a simulation approach. The policy simulations reflect the policy shocks typical of many LDCs; most importantly, the controversial policy instruments are addressed, namely interest rate liberalization, exchange rate devaluation, and the budget deficit. However, what the book does not hazard is a departure from single-shot types of policy experiment. As this reviewer has shown recently, a policy adjustment programme, as adopted by most LDCs, typically involves a simultaneous introduction of policy instruments (see, Murinde, V., Macroeconomic Policy Modeling for Developing Countries, Aldershot, 1993). Simulations based on simultaneous introduction of policy instruments comprise of feasible promising research idea for extending the model in the book , in addition to other useful suggestions for further research spelt out in the epilogue in Chapter 6.
Notwithstanding the above quibbles, this book deserves a lot of credit for proposing and implementing a unified macroeconomic framework within which the varied experience and empirical evidence on informal credit markets and parallel foreign exchange markets in many LDCs can be analyzed. I recommend the book; many errors in strategic policy design and implementation might well be avoided if Informal Financial Markets in Developing Countries became compulsory reading for research departments of central banks which are seeking to achieve sound and sustainable adjustments in troubled domestic economies, especially those LDCs which are still plagued by informal financial markets. If only the book could inspire researchers in those economies and in multilateral organizations, especially the World Bank and the IMF, to generate country-specific models that structurally recognize the existence of informal markets!"