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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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  • Yin-wong Cheung

    (University of California, Santa Cruz)

  • Kon S. Lai

    (California State University, Los Angeles)

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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Bibliographic 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
Date of revision:
Handle: RePEc:hkm:wpaper:092007

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

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Cited by:
  1. Couharde, Cécile & Coulibaly, Issiaka & Guerreiro, David & Mignon, Valérie, 2013. "Revisiting the theory of optimum currency areas: Is the CFA franc zone sustainable?," Journal of Macroeconomics, Elsevier, Elsevier, vol. 38(PB), pages 428-441.

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