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Financial stability in small open economy under political uncertainty

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  • Onour, Ibrahim
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    Abstract

    In this paper we model financial stability in small open economy enduring political uncertainty and operating under dual exchange markets, a free exchange rate applicable to wide range of private capital transactions and controlled exchange rate applicable to some official transactions. The finding in the paper indicate, given that capital outflow is kept at minimal level there exist steady state equilibrium exchange rates. The level of initial official reserves determine the length of time needed for the process to adjust towards a new steady state equilibrium. The lower initial official reserve level is, the longer time is needed to recover from a shock and adjust towards a new equilibrium steady state. When fiscal deficit and declining official reserves force the government to abandon the dual exchange system in favor of floating single exchange rate system, our model predict depreciation of foreign exchange rates is identical to domestic money growth.

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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 29883.

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    Date of creation: 02 Mar 2011
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    Handle: RePEc:pra:mprapa:29883

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    Keywords: parallel rate; official rate; Stability; Steady-state.;

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    1. Chander Kant, 2002. "What is Capital Flight?," The World Economy, Wiley Blackwell, vol. 25(3), pages 341-358, 03.
    2. Ibrahim Onour, 2000. "Unification of Dual Foreign Exchange Markets," Economic Change and Restructuring, Springer, vol. 33(3), pages 171-184, October.
    3. Onour, Ibrahim & Cameron, Norman, 1997. "Parallel Market Premia and Misalignment of Official Exchange Rates," MPRA Paper 15537, University Library of Munich, Germany.
    4. 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.
    5. Kiguel, Miguel & O'Connell, Stephen A, 1995. "Parallel Exchange Rates in Developing Countries," World Bank Research Observer, World Bank Group, vol. 10(1), pages 21-52, February.
    6. Saul Lizondo, Jose, 1987. "Unification of dual exchange markets," Journal of International Economics, Elsevier, vol. 22(1-2), pages 57-77, February.
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