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Nominal Exchange Rate Flexibility and Real Exchange Rate Adjustment: Evidence from Dual Exchange Rates in Developing Countries

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Author Info
Yin-Wong Cheung ()
Kon S. Lai

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Abstract

This study investigates whether exchange rate flexibility aids real exchange rate adjustment based on intra-period data on dual exchange rates from developing countries. Specifically, it analyzes whether the flexible parallel market rate produces faster or slower real exchange rate adjustment than the much less flexible official rate does. Half-life estimates of adjustment speeds are obtained using fractional time series analysis. We find no systematic evidence that greater exchange rate flexibility tends to produce faster or slower real exchange rate adjustment, albeit there is substantial heterogeneity in speed estimates across countries. With officially pegged exchange rates, developing countries often use parallel exchange markets as a back-door channel to facilitate real exchange rate adjustment, but the empirical evidence suggests that these parallel markets in most cases fail to help promote real rate adjustment.

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Publisher Info
Paper provided by CESifo GmbH in its series CESifo Working Paper Series with number CESifo Working Paper No. 1512.

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Date of creation: 2005
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Handle: RePEc:ces:ceswps:_1512

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Related research
Keywords: real exchange rate fractional time series half life

Find related papers by JEL classification:
C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models
F31 - International Economics - - International Finance - - - Foreign Exchange

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  1. Cheung, Yin-Wong & Lai, Kon S., 2000. "On the purchasing power parity puzzle," Journal of International Economics, Elsevier, vol. 52(2), pages 321-330, December. [Downloadable!] (restricted)
  2. Booth, G. Geoffrey & Mustafa, Chowdhury, 1991. "Long-run dynamics of black and official exchange rates," Journal of International Money and Finance, Elsevier, vol. 10(3), pages 392-405, September. [Downloadable!] (restricted)
  3. Diebold, Francis X & Husted, Steven & Rush, Mark, 1991. "Real Exchange Rates under the Gold Standard," Journal of Political Economy, University of Chicago Press, vol. 99(6), pages 1252-71, December. [Downloadable!] (restricted)
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  4. Phylaktis, Kate, 1991. "The black market for dollars in Chile," Journal of Development Economics, Elsevier, vol. 37(1-2), pages 155-172, November. [Downloadable!] (restricted)
  5. Alesina, Alberto & Perotti, Roberto, 1995. "Taxation and redistribution in an open economy," European Economic Review, Elsevier, vol. 39(5), pages 961-979, May. [Downloadable!] (restricted)
  6. Cheung, Yin-Wong & Lai, Kon S. & Bergman, Michael, 2004. "Dissecting the PPP puzzle: the unconventional roles of nominal exchange rate and price adjustments," Journal of International Economics, Elsevier, vol. 64(1), pages 135-150, October. [Downloadable!] (restricted)
    Other versions:
  7. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June. [Downloadable!] (restricted)
  8. Cheung, Yin-Wong & Diebold, Francis X., 1994. "On maximum likelihood estimation of the differencing parameter of fractionally-integrated noise with unknown mean," Journal of Econometrics, Elsevier, vol. 62(2), pages 301-316, June. [Downloadable!] (restricted)
    Other versions:
  9. repec:rus:hseeco:181565 is not listed on IDEAS
  10. Canzoneri, Matthew B. & Cumby, Robert E. & Diba, Behzad, 1999. "Relative labor productivity and the real exchange rate in the long run: evidence for a panel of OECD countries," Journal of International Economics, Elsevier, vol. 47(2), pages 245-266, April. [Downloadable!] (restricted)
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  11. Pozo, Susan & Wheeler, Mark, 1999. "Expectations and the Black Market Premium," Review of International Economics, Blackwell Publishing, vol. 7(2), pages 245-53, May.
  12. Jose De Gregorio & Holger C. Wolf & Alberto Giovannini, 1994. "International Evidence on Tradables and Nontradables Inflation," IMF Working Papers 94/33, International Monetary Fund.
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  13. Murray, Christian J. & Papell, David H., 2002. "The purchasing power parity persistence paradigm," Journal of International Economics, Elsevier, vol. 56(1), pages 1-19, January. [Downloadable!] (restricted)
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  14. Kouretas, Georgios P & Zarangas, Leonidas P, 1998. "A Cointegration Analysis of the Official and Parallel Foreign Exchange Markets for Dollars in Greece," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 3(3), pages 261-76, July. [Downloadable!] (restricted)
  15. Benigno, Gianluca, 2004. "Real exchange rate persistence and monetary policy rules," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 473-502, April. [Downloadable!] (restricted)
  16. Carmen M. Reinhart & Kenneth S. Rogoff, 2004. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," The Quarterly Journal of Economics, MIT Press, vol. 119(1), pages 1-48, February. [Downloadable!] (restricted)
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  17. Cheung, Yin-Wong & Lai, Kon S, 1993. "A Fractional Cointegration Analysis of Purchasing Power Parity," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(1), pages 103-12, January.
  18. Dornbusch, Rudiger, et al, 1983. "The Black Market for Dollars in Brazil," The Quarterly Journal of Economics, MIT Press, vol. 98(1), pages 25-40, February. [Downloadable!] (restricted)
  19. Charles Engel & James C. Morley, 2001. "The Adjustment of Prices and the Adjustment of the Exchange Rate," NBER Working Papers 8550, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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