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Contractionary devaluation with black markets for foreign exchange

  • Steven B. Kamin
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    Analyses of the possible contractionary effects of exchange rate devaluation typically assume the foreign exchange market to be unified, thereby ignoring the large fraction of transactions taking place in the black market for foreign exchange that exist in many developing countries. This paper explores how the existence of these black markets may alter the impact of an official devaluation on aggregate output. It is argued that devaluations will be followed by less immediate contraction in a black­market economy than in a unified-market economy, both because the black market exchange rate will depreciate by less than the official rate, and because many of the devaluation's contractionary effects will occur in anticipation of the official devaluation itself. These propositions are tested using a simple numerical simulation model.

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    File URL: http://www.federalreserve.gov/pubs/ifdp/1990/370/default.htm
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    File URL: http://www.federalreserve.gov/pubs/ifdp/1990/370/ifdp370.pdf
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    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 370.

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    Date of creation: 1990
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    Handle: RePEc:fip:fedgif:370
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    1. Steven B. Kamin, 1988. "Devaluation, exchange controls, and black markets for foreign exchange in developing countries," International Finance Discussion Papers 334, Board of Governors of the Federal Reserve System (U.S.).
    2. 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.
    3. P. Krugman & L. Taylor, 1976. "Contractionary Effects of Devaluations," Working papers 191, Massachusetts Institute of Technology (MIT), Department of Economics.
    4. Hanson, James A., 1983. "Contractionary devaluation, substitution in production and consumption, and the role of the labor market," Journal of International Economics, Elsevier, vol. 14(1-2), pages 179-189, February.
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