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The Limited Viability of Dual Exchange-Rate Regimes

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  • Jacob A. Frenkel
  • Assaf Razin

Abstract

This paper examines the viability of dual exchange-rate regimes. Typically, under such a regime the exchange rates applicable to current-account(commercial) transactions and to capital-account (financial) transactions differ from each other. This difference may be determined in the free market if the authorities peg the commercial exchange rate and set a binding quota on external borrowing, or it may result from direct pegging of both exchange rates. The analysis starts with a specification of the characteristics of the distortion introduced by the exchange-rate premium (that is, the percentage discrepancy between the financial and the commercial exchange rates), and then provides explicit formula for the equilibrium premium, for its evolution over time and for the welfare cost induced by the distortion. The paper outlines the set of policy options consistent with sustaining a permanently viable dual exchange-rate system and highlights the severe constraints that intertemporal solvency requirements of the private sector and of the government impose on the long-run viability of the regime. The paper concludes with an analysis of the monetary changes associated with dual exchange-rate policies and draws the implications of such a regime for the intertemporal distribution of taxes and for the intergenerational distribution of welfare.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1902.

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Date of creation: Apr 1986
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Handle: RePEc:nbr:nberwo:1902

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  1. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April.
  2. Persson, Torsten, 1984. "Real transfers in fixed exchange rate systems and the international adjustment mechanism," Journal of Monetary Economics, Elsevier, vol. 13(3), pages 349-369, May.
  3. Marion, Nancy Peregrim, 1981. "Insulation Properties of a Two-Tier Exchange Market in a Portfolio Balance Model," Economica, London School of Economics and Political Science, vol. 48(189), pages 61-70, February.
  4. Aizenman, Joshua, 1985. "Adjustment to monetary policy and devaluation under two-tier and fixed exchange rate regimes," Journal of Development Economics, Elsevier, vol. 18(1), pages 153-169.
  5. Stockman, Alan C., 1982. "The order of economic liberalization: lessons from Chile and Argentina : A comment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 17(1), pages 187-192, January.
  6. Sebastian Edwards & Liaquat Ahamed, 1986. "Economic Adjustment and Exchange Rates in Developing Countries," NBER Books, National Bureau of Economic Research, Inc, number edwa86-1, octubre-d.
  7. Jeremy Greenwood & Kent P. Kimbrough, 1987. "An Investigation in the Theory of Foreign Exchange Controls," Canadian Journal of Economics, Canadian Economics Association, vol. 20(2), pages 271-88, May.
  8. Stockman, Alan C, 1980. "A Theory of Exchange Rate Determination," Journal of Political Economy, University of Chicago Press, vol. 88(4), pages 673-98, August.
  9. Dornbusch, Rudiger, 1976. " The Theory of Flexible Exchange Rate Regimes and Macroeconomic Policy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 78(2), pages 255-75.
  10. Flood, Robert P., 1978. "Exchange rate expectations in dual exchange markets," Journal of International Economics, Elsevier, vol. 8(1), pages 65-77, February.
  11. McKinnon, Ronald I., 1982. "The order of economic liberalization: Lessons from Chile and Argentina," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 17(1), pages 159-186, January.
  12. Adams, Charles & Greenwood, Jeremy, 1985. "Dual exchange rate systems and capital controls: An investigation," Journal of International Economics, Elsevier, vol. 18(1-2), pages 43-63, February.
  13. Brian Jacob & Lars Lefgren, 2007. "The Effect of Grade Retention on High School Completion," NBER Working Papers 13514, National Bureau of Economic Research, Inc.
  14. Helpman, Elhanan, 1981. "An Exploration in the Theory of Exchange-Rate Regimes," Scholarly Articles 3445091, Harvard University Department of Economics.
  15. Frenkel, Jacob A., 1982. "The order of economic liberalization: Lessons from Chile and Argentina : A comment," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 17(1), pages 199-201, January.
  16. Obstfeld, Maurice, 1986. "Capital controls, the dual exchange rate, and devaluation," Journal of International Economics, Elsevier, vol. 20(1-2), pages 1-20, February.
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Cited by:
  1. Dudley Cooke, 2007. "How do Capital Controls Affect the Transmission of Foreign Shocks?," EPRU Working Paper Series 07-02, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  2. Lukas Mohler & Michael Seitz, 2012. "The gains from variety in the European Union," Review of World Economics (Weltwirtschaftliches Archiv), Springer, vol. 148(3), pages 475-500, September.
  3. Mohler, Lukas & Seitz, Michael, 2010. "The Gains from Variety in the European Union," Discussion Papers in Economics 11477, University of Munich, Department of Economics.

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