Working Paper: NBER ID: w2220
Authors: William H. Branson; Jorge Braga de Macedo
Abstract: The ineffectiveness of real devaluation as stabilization policy does not imply that the nominal exchange rate should be held constant in the face of a domestic inflation. In this circumstance, import duties and export subsidies would have to be escalated to counter the potential erosion of the trade balance. This escalation of trade barriers generates a rising black market premium and offers increasing incentives to smuggling, already a pervasive problem in the African countries. As a consequence, the central bank would find it more and more difficult to hold the nominal exchange rate constant. This leads us to consider a passive exchange rate policy of stabilizing the exchange rate by moving the nominal rate in line with domestic inflation. If such passive policy is not accompanied by the elimination of trade barriers, however, the black market premium will not disappear. Unless exchange rate policy and trade policy are consistent with each other, the smuggler's blues will reach the central bank. Indeed, this is not just a theoretical possibility, it is the major lesson from the recent experience of Sudan.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Domestic inflation (E31) | Increased trade barriers (F14) |
| Increased trade barriers (F14) | Rising black market premium (G13) |
| Passive exchange rate policy + Elimination of trade barriers (O24) | Stabilized real exchange rate (F31) |
| Nominal exchange rate policies + Trade barriers (F31) | Black market premium (F16) |
| Escalation of trade barriers (F13) | Smuggling incentives (H26) |