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Capital Controls, The Dual Exchange Rate, and Devaluation

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  • Maurice Obstfeld

Abstract

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.

Suggested Citation

  • Maurice Obstfeld, 1984. "Capital Controls, The Dual Exchange Rate, and Devaluation," NBER Working Papers 1324, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1324
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    References listed on IDEAS

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    1. Dornbusch, Rudiger, 1973. "Devaluation, Money, and Nontraded Goods," American Economic Review, American Economic Association, vol. 63(5), pages 871-880, December.
    2. Boyer, Russell S, 1977. "Devaluation and Portfolio Balance," American Economic Review, American Economic Association, vol. 67(2), pages 54-63, March.
    3. Obstfeld, Maurice, 1981. "Capital Mobility and Devaluation in an Optimizing Model with Rational Expectations," American Economic Review, American Economic Association, vol. 71(2), pages 217-221, May.
    4. Calvo, Guillermo A., 1981. "Devaluation: Levels versus rates," Journal of International Economics, Elsevier, vol. 11(2), pages 165-172, May.
    5. Flood, Robert P., 1978. "Exchange rate expectations in dual exchange markets," Journal of International Economics, Elsevier, vol. 8(1), pages 65-77, February.
    6. Cumby, Robert E., 1984. "Monetary policy under dual exchange rates," Journal of International Money and Finance, Elsevier, vol. 3(2), pages 195-208, August.
    7. Lapan, Harvey E & Enders, Walter, 1978. "Devaluation, Wealth Effects, and Relative Prices," American Economic Review, American Economic Association, vol. 68(4), pages 601-613, September.
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    Cited by:

    1. Aaron Tornell, 1990. "Propiedades aislantes de los tipos de cambio duales: Un modelo neoclásico," Estudios Económicos, El Colegio de México, Centro de Estudios Económicos, vol. 5(1), pages 125-156.
    2. Ricardo Hausmann, 1995. "Dealing with Negative Oil Shocks: The Venezuelan Experience in the Eighties," Research Department Publications 4010, Inter-American Development Bank, Research Department.
    3. Ricardo Hausmann, 1995. "Manejo de sacudidas petroleras negativas: la experiencia venezolana en los años 80," Research Department Publications 4011, Inter-American Development Bank, Research Department.
    4. Stockman, Alan C & Hernandez D, Alejandro, 1988. "Exchange Controls, Capital Controls, and International Financial Markets," American Economic Review, American Economic Association, vol. 78(3), pages 362-374, June.
    5. Calvo, Guillermo A. & Vegh, Carlos A., 1999. "Inflation stabilization and bop crises in developing countries," Handbook of Macroeconomics,in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 24, pages 1531-1614 Elsevier.
    6. Xavier Sala-i-Martin & Jeffrey Sachs, 1991. "Fiscal Federalism and Optimum Currency Areas: Evidence for Europe From the United States," NBER Working Papers 3855, National Bureau of Economic Research, Inc.
    7. Agenor, Pierre-Richard & Khan, Mohsin S., 1996. "Foreign currency deposits and the demand for money in developing countries," Journal of Development Economics, Elsevier, vol. 50(1), pages 101-118, June.
    8. Calvo, Guillermo A. & Reinhart, Carmen M. & Vegh, Carlos A., 1995. "Targeting the real exchange rate: theory and evidence," Journal of Development Economics, Elsevier, vol. 47(1), pages 97-133, June.
    9. repec:kap:iaecre:v:6:y:2000:i:3:p:427-437 is not listed on IDEAS
    10. Impavido, Gregorio & Musalem, Alberto R. & Vittas, Dimitri, 2002. "Contractual savings in countries with a small financial sector," Policy Research Working Paper Series 2841, The World Bank.
    11. Frenkel, Jacob A. & Razin, Assaf, 1989. "Exchange-rate management viewed as tax policies," European Economic Review, Elsevier, vol. 33(4), pages 761-781, April.
    12. Chetan Subramanian & Jungsoo Park, 2004. "Exchange Rate Based Stabilization with Sudden Restrictions on Capital Flows," Econometric Society 2004 Far Eastern Meetings 748, Econometric Society.
    13. Kaufmann, Daniel & O'Connell, Stephen A., 1999. "The macroeconomics of delayed exchange-rate unification : theory and evidence from Tanzania," Policy Research Working Paper Series 2060, The World Bank.
    14. Auernheimer, Leonardo & George, Susan Mary, 1997. "Shock versus gradualism in models of rational expectations: the case of trade liberalization," Journal of Development Economics, Elsevier, vol. 54(2), pages 307-322, December.
    15. Eran Yashiv, 1997. "Capital Controls as Taxation Policy," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 4(3), pages 263-276, July.
    16. Velasco, Andres, 1995. "Increasing returns and cyclical international capital movements," Economics Letters, Elsevier, vol. 48(3-4), pages 345-351, June.
    17. Robert Flood & Nancy Marion, 1989. "Risk Neutrality and the Two-Tier Foreign Exchange Market: Evidence from Belgium," NBER Working Papers 3015, National Bureau of Economic Research, Inc.
    18. S Coleman & M Karoglou, 2010. "Monetary Variability and Monetary Variables in the Franc Zone," Economic Issues Journal Articles, Economic Issues, vol. 15(2), pages 17-48, September.
    19. Kathleen Dorsainvil, 2000. "Welfare effects of exchange controls: An application to the Haitian economy," International Advances in Economic Research, Springer;International Atlantic Economic Society, vol. 6(3), pages 427-437, August.
    20. Shigeto Kitano, 2004. "Macroeconomic effect of capital controls as a safeguard against the capital inflow problem," The Journal of International Trade & Economic Development, Taylor & Francis Journals, vol. 13(3), pages 233-263.
    21. Ricardo Hausmann, 1995. "Dealing with Negative Oil Shocks: The Venezuelan Experience in the Eighties," IDB Publications (Working Papers) 6066, Inter-American Development Bank.
    22. Alberto Giovannini & Jan Won Park, 1989. "Capital Controls and International Trade Finance," NBER Working Papers 3112, National Bureau of Economic Research, Inc.
    23. Joshua Aizenman, 1986. "Country Risk, Asymmetric Information and Domestic Policies," NBER Working Papers 1880, National Bureau of Economic Research, Inc.
    24. Jacob A. Frenkel & Assaf Razin, 1986. "The Limited Viability of Dual Exchange-Rate Regimes," NBER Working Papers 1902, National Bureau of Economic Research, Inc.

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