Financial sector reforms and stochastic policy simulations: A flow of funds model for India

Abstract

We apply stochastic simulation methods to a system-wide flow of funds model for India for 1951-94. We address two issues; first, the impact of financial reforms on interest rates and loanable funds, and second, the robustness of policy where there is uncertainty about the true model. We find considerable variation in policy risk depending on the policy instrument and the policy regime. Interest rate risks are greater in the controlled regime; quantity risks are greater in the decontrolled regime. Outcomes also depend on controls on intermediaries: more heavily controlled banks respond differently from other less heavily controlled financial intermediaries.