Credibility, Real Interest Rates, and the Optimal Speed of Trade Liberalization

42 Pages Posted: 24 Jan 2007 Last revised: 12 Dec 2022

See all articles by Kenneth Froot

Kenneth Froot

Harvard University Graduate School of Business; National Bureau of Economic Research (NBER)

Date Written: August 1987

Abstract

This paper investigates the effects of imperfectly credible trade liberalization programs on welfare and the allocation of real resources. We present a rational expectations model in which a government, with limited access to international financial markets may be forced to abort a liberalization program if hard-currency reserves are depleted too quickly. The liberalization's lack of perfect credibility arts as a distortion which becomes (rationally) intensified under the typical first-best policy of a direct move to free trade. A gradual lowering of trade barriers turns out to he welfare-superior to an immediate liberalization, and to improve the chance that. the program will ultimately succeed. We then derive the optimal speed of liberalization, the intertemporal allocation of resources, and the liberalization program's credibility.

Suggested Citation

Froot, Kenneth, Credibility, Real Interest Rates, and the Optimal Speed of Trade Liberalization (August 1987). NBER Working Paper No. w2358, Available at SSRN: https://ssrn.com/abstract=349180

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