Capital controls, the dual exchange rate, and devaluation
This paper re-examines the effect of devaluation under capital-account restrictions, adding to traditional formulations the seemingly minor (but realistic) assumption that central-bank reserves earn interest. The extra assumption has important implications. In an intertemporal model, devaluation is no longer neutral in the long run as it is in the literature on the monetary approach to the balance of payments. Further, the economy may possess multiple stationary states, some of them unstable.The analysis confirms, however, that even large devaluations must improve the balance of payments if the economy is initially at a stable stationary position. A by-product of the analysis is a pricing formula for the financial exchange rate in a dual exchange rate system. That formula is consistent with recent consumption-based models of asset pricing.
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- Lapan, Harvey E & Enders, Walter, 1978. "Devaluation, Wealth Effects, and Relative Prices," American Economic Review, American Economic Association, vol. 68(4), pages 601-13, September.
- Obstfeld, Maurice, 1981.
"Capital Mobility and Devaluation in an Optimizing Model with Rational Expectations,"
American Economic Review,
American Economic Association, vol. 71(2), pages 217-21, May.
- Maurice Obstfeld, 1980. "Capital Mobility and Devaluation in an Optimizing Model with Rational Expectations," NBER Working Papers 0557, National Bureau of Economic Research, Inc.
- Cumby, Robert E., 1984.
"Monetary policy under dual exchange rates,"
Journal of International Money and Finance,
Elsevier, vol. 3(2), pages 195-208, August.
- Flood, Robert P., 1978. "Exchange rate expectations in dual exchange markets," Journal of International Economics, Elsevier, vol. 8(1), pages 65-77, February.
- Calvo, Guillermo A., 1981. "Devaluation: Levels versus rates," Journal of International Economics, Elsevier, vol. 11(2), pages 165-172, May.
- Dornbusch, Rudiger, 1973. "Devaluation, Money, and Nontraded Goods," American Economic Review, American Economic Association, vol. 63(5), pages 871-80, December.
- Boyer, Russell S, 1977. "Devaluation and Portfolio Balance," American Economic Review, American Economic Association, vol. 67(2), pages 54-63, March.
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