Stabilization policy performance under dual exchange regimes

Mary Rose Leacy, Fordham University


Multiple exchange rate regimes have been widely used in LDCs. The most common arrangement is the dual rate regime, using a managed primary rate for current account transactions and a separate secondary rate for capital account transactions. This study compares a pooled sample of seven dual rate regimes and seven non-dual rate countries. Our basic approach is to supplement standard reduced form equations for output, inflation, and capital flows with a number of VARs to investigate causal patterns in the data. Our empirical results generally support three broad conclusions. First, one objective of dual rate regimes is to reduce the impact of devaluation on output. We find weak evidence of this insulating effect. Devaluation of the secondary rate has no significant impact on output. Second, we find a buffering effect on inflation. In several formulations, a devaluation of the secondary rate had a negative effect on inflation and money growth for a given primary rate devaluation. What makes these results interesting is devaluation of the secondary rate also appears to reduce capital outflows, proxied by the level of reserves. Devaluation of the primary rate in non-dual rate regimes had a negative impact on reserves. In the dual rate regimes, devaluation of the primary rate had similar results to the secondary rate devaluation either a smaller negative effect than in non-dual rate regimes or a positive effect on reserves. These results differ from previous studies that only use nominal premiums to analyze the impacts of both black market and official dual rates. Contrary to the results reported here, these studies tend to find dual and black rate premiums have inflationary impacts similar to one another and to non-dual rate devaluations. Though they need to be interpreted with caution, our results show a consistent pattern across annual and quarterly samples: dual rate regimes have some value as a transitional device to buffer inflation and output fluctuations during periods of major financial instability.

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Recommended Citation

Leacy, Mary Rose, "Stabilization policy performance under dual exchange regimes" (1997). ETD Collection for Fordham University. AAI9730099.