Capital controls, the dual exchange rate, and devaluation

1999

This paper shows that the risk of devaluation can be an important factor accounting for the stylized facts of exchange-rate-based stabilizations. This conclusion follows from studying the quantitative implications of a two-sector equilibrium business cycle model of a small open economy calibrated to Mexico's 1987-1994 stabilization plan. In the model, devaluation risk creates a time-variant interest rate differential that acts as a stochastic tax on money demand, labor supply, investment, and saving. Under incomplete markets, this tax induces endogenous state-contingent wealth effects via fiscal adjustment and suboptimal investment. Devaluation risk entails large welfare costs in this environment.

Economics Letters, 2012

Central banks, wanting to devalue their currency, often intervene in the foreign exchange market by buying up foreign currency. Such interventions even if effective lead to a build up of foreign exchange reserves. This paper argues that the coupling of devaluation and reserve build up can be avoided if the central bank intervention takes the form of a 'schedule', that is, commitment to buying and selling conditional on the exchange rate.

1986

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 exchangerate 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

ISU General Staff Papers, 1976

Judging by recent issues of this, and other Journals, there is still a keen interest in determining the causes of, and cures for, Balance of Trade and Payments disequilibria. The emergence of the Portfolio Balance Approach-'' has led to viewing Balance of Trade deficits and surpluses as caused by discrepancies between desired and actual wealth holdings, and Balance of Payments deficits (surpluses) as caused by discrepancies between desired and actual money holdings. Thus, Balance of Trade and Payments deficits and surpluses are viewed as representing disequilibrium within the asset markets. Within this framework several authors have asked what self-correcting tendencies exist and whether a devaluation facilitates any tendency towards selfcorrection. Disciplines

Journal of Money, Credit and Banking, 1984

The collapse of a fixed exchange rate is typically marked by a sudden balance-of-payments crisis in which "speculators" fleeing from the domestic currency acquire a large portion of the central bank's foreign exchange holdings. Faced with such an attack, the central bank often withdraws temporarily from the foreign exchange market, allowing the exchange rate to float freely before devaluing and returning to a fixed-rate regime. This paper links the timing of the initial speculative attack to the magnitude of the expected devaluation and to the length of the transitional period of floating. An implication of the analysis is that there exist devaluations so sharp and transition periods so short that a crisis must occur the moment the market first learns that the current exchange parity will eventually be altered. For sufficiently long transition periods, the floating exchange rate "overshoots" its new peg before appreciating back toward it; for shorter periods, the rate depreciates monotonically to its new fixed level. Accordingly, the central bank's return to the foreign exchange market can occasion a capital outflow or a capital inflow.

2008

Journal of International Economics, 1982

This paper analyzes aspects of the economics of the optimal management of exchange rates. It shows that the choice of the optimal exchange rate regime depends on the nature and the origin of the stochastic shocks that affect the economy. Generally, the higher is the variance of real shocks which affect the supply of goods, the larger becomes the desirability of fixity of exchange rates. The rationale for that implication is that the balance of payments serves as a shock absorber which mitigates the effect of real shocks on consumption. The importance of this factor diminishes the larger is the economy's access to world capital markets. On the other hand, the desirability of exchange rate flexibility increases the larger are the variances of the shocks to the demand for money, to the supply of money, to foreign prices and to purchasing power parities. All of these shocks exert a similar effect and their sum is referred to as the "effective monetary shock." It is also shown that the desirability of exchange rate flexibility increases the larger is the propensity to save out of transitory income. When the analysis is extended to an economy which produces traded and non-traded goods it is shown that the desirability of exchange rate flexibility diminishes the higher is the share of non-traded goods relative to traded goods and the lower are the elasticities of demand and supply of the two goods.

Journal of Development Economics, 1986

Journal of Macroeconomics, 1981

IMF Economic Review, 2013

The paper analyzes optimal policy in a simple small open economy model with price setting frictions. In particular, the paper studies the optimal response of the nominal exchange rate following a terms-of-trade shock. The paper departs from the New Keynesian (NK) literature in that it explicitly models internationally traded commodities as intermediate inputs in the production of local final goods and assume that the small open economy takes this price as given. This modification is not only in line with the long standing tradition of small open economy models, but also changes the optimal movements in the exchange rate. In contrast with the recent Small Open Economy NK literature, the model in this paper is able to reproduce the comovement between the nominal exchange rate and the price of exports, as it has been documented in the commodity currencies literature. Although the paper shows that there are preferences for which price stability is optimal even without flexible fiscal instruments, the model suggests that more attention should be given to the coordination between monetary and fiscal policy (taxes) in small open economies that are heavily dependent on exports of commodities. The model the paper proposes is a useful framework to study fear of floating. [JEL E52, F41, H21]