Welfare effects of liberalization reforms with distortions in financial and labor markets

Liberalization can have ambiguous effects on welfare and produce unexpected macroeconomic changes because of conflicting effects stemming from distortions in other markets both within the same period and across time. This approach presents a two-period intertemporal model of a small open economy to examine the welfare effects of removing one distortion (financial repression, tariffs) while others (wage and price rigidity) remain in place. The equilibrium conditions from this model are used to derive welfare effects of various liberalization policies and to determine optimal levels of the policy variables.