Working Paper: NBER ID: w1659
Authors: Rudiger Dornbusch
Abstract: The exchange rate consistent with high employment and a balanced current account are rarely the same as the rates consistent with asset market equilibrium at interest rates policy makers wish to prevail. Whenever rates are freely determined the assets markets prevail and the results may be hard to live with, or at least harder than would appear to be the case of special exchange rates and capital controls which are used to isolate home assets markets from the world capital market. This paper investigates the motive for choosing capital controls and special exchange rates, the principal forms and some of the experience. We look in particular at three institutional arrangements:(1) dual exchange rates separating current and capital account transactions,(2) black or parallel markets for foreign exchange,(3) exchange rate guarantees, dollar deposits and dollar-linked domestic debt.
Keywords: exchange rates; capital controls; asset markets; dual exchange rates
JEL Codes: F31; F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| high mobility of capital (F20) | severe restrictions on domestic policies (P33) |
| home interest rates must be set high enough (E43) | currency stability (F31) |
| falling domestic interest rates (below foreign rates) (E43) | capital flight (F21) |
| capital flight (F21) | depletion of reserves under fixed rates or depreciation of the exchange rate under flexible rates (F31) |
| dual exchange rates (F31) | manage expectations of asset holders (G19) |
| dual exchange rates (F31) | stabilize the economy (E63) |
| expectations of asset holders (G32) | stabilize the economy (E63) |