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

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Author Info
Yin-wong Cheung (University of California, Santa Cruz)
Kon S. Lai (California State University, Los Angeles)

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Abstract

This study investigates whether greater nominal exchange rate flexibility aids real exchange rate adjustment based on data from dual exchange rates in developing countries. Specifically, we analyze whether the more flexible parallel market rate produces faster real exchange rate adjustment than the less flexible official rate does. Half-life estimates of adjustment speeds are obtained from fractional time series analysis. We find no systematic evidence that greater exchange rate flexibility tends to produce either faster or slower real exchange rate adjustment, albeit there is substantial cross-country heterogeneity in speed estimates. With official rates pegged to the dollar, many developing countries use parallel exchange markets as a back-door channel to facilitate real exchange rate adjustment. The evidence suggests, however, that these parallel markets often fail to speed up real rate adjustment.

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Publisher Info
Paper provided by Hong Kong Institute for Monetary Research in its series Working Papers with number 092007.

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Length: 29 pages
Date of creation: May 2007
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Handle: RePEc:hkm:wpaper:092007

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Related research
Keywords: Real exchange rate; Fractional time series; Half life; Adjustment speed;

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

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