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The Limited Viability of Dual Exchange-Rate Regimes

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Author Info
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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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. 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, pages 199-201. [Downloadable!] (restricted)
  2. 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. [Downloadable!] (restricted)
  3. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April. [Downloadable!] (restricted)
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  4. 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. [Downloadable!] (restricted)
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  5. McKinnon, Ronald I., 1982. "The order of economic liberalization: Lessons from Chile and Argentina," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 17, pages 159-186. [Downloadable!] (restricted)
  6. Helpman, Elhanan, 1981. "An Exploration in the Theory of Exchange-Rate Regimes," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 865-90, October. [Downloadable!] (restricted)
  7. 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, pages 187-192. [Downloadable!] (restricted)
  8. 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. [Downloadable!] (restricted)
  9. Dornbusch, Rudiger, 1976. " The Theory of Flexible Exchange Rate Regimes and Macroeconomic Policy," Scandinavian Journal of Economics, Blackwell Publishing, vol. 78(2), pages 255-75.
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  10. Flood, Robert P., 1978. "Exchange rate expectations in dual exchange markets," Journal of International Economics, Elsevier, vol. 8(1), pages 65-77, February. [Downloadable!] (restricted)
  11. 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. [Downloadable!] (restricted)
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