Tariff liberalization policy and financial restrictions

The purpose of this paper is to assess how restrictions on capital mobility affect adjustment to a tariff liberalization policy. This is done by comparing the adjustment process under free and restricted convertibility of foreign assets in a regime where the commercial exchange rate is pegged. It is shown that starting from an equilibrium characterized by significant scarcity of foreign assets, a policy of simultaneous liberalization of both current and capital account would cause a larger drop in domestic goods prices than would the short-run effects of tariff liberalization alone. In such an economy the effect of liberalization of capital controls is to generate current account surplus, whereas tariff liberalization generates current account deficit.