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Special exchange rates for capital account transactions (English)

The governments of developing countries are constrained in the effective implementation of domestic policy by the interlinkages of national and international financial markets. Domestic macroeconomic conditions are influenced by the interaction of national and world interest rates and prices, and through the impact of real exchange rates on employment. The domestic responses to changes in these factors are often strong and rapid. This article suggests that dual rates can indeed be used successfully as a strictly transitory policy to offset sudden shocks in capital markets. The article develops models which indicate why these dual systems are able to prevent inflationary or recessionary pressures caused by a misaligned exchange rate in the short term. While free capital account rates can cut the flow of capital flight, however, a dual rate system cannot prevent a possibly equivalent loss of foreign reserves that will ultimately result because of the impact of the overvaluation of the commercial rate on the trade balance. In the longer term, a dual rate system with a misaligned commercial rate exacerbates the government's deficit; ultimately, real wages must be cut and real interest rates raised to generate sufficient foreign exchange to finance the external debt. Thus a dual rate works well if the commercial rate is maintained close to the equilibrium level.

Details

  • Author

    Dornbusch, Rudiger

  • Document Date

    1986/09/30

  • Document Type

    Journal Article

  • Report Number

    8738

  • Volume No

    1

  • Total Volume(s)

    1

  • Disclosure Date

    2010/07/01

  • Doc Name

    Special exchange rates for capital account transactions

  • Keywords

    capital account transaction;free market;foreign asset;commercial rates;exchange rate;Exchange Rates;rate of depreciation;free rate;steady state;real money;asset market;real value of saving;Massachusetts Institute of Technology;high real interest rate;official exchange rate policy;relative price of goods;return on foreign asset;access to foreign exchange;real government spending;trade balance;price level;trade deficit;foreign asset holding;dual exchange rate;black market;fixed exchange rate;purchasing power parity;multiple exchange rate;real exchange rate;trade surplus;foreign interest rate;capital market integration;rate of inflation;Foreign Exchange Reserve;exchange rate system;foreign exchange market;foreign exchange transaction;international financial market;overvalued exchange rate;international financial statistic;commercial transaction;loss in confidence;open market operation;stable exchange rate;national income account;average exchange rate;effective exchange rate;international capital flow;exchange rate unification;level of wealth;exchange rate depreciation;nominal interest rate;international exchange rate;world war i;mobility of capital;free capital mobility;exchange rate action;world interest rate;undervalued exchange rate;parallel market rate;exchange rate risk;domestic currency price;steady state level;exchange rate movement;Balance of Trade;exchange rate arrangement;exchange rate increase;government budget deficit;balance of payment;decline in investment;class of goods;domestic interest rate;dual market;goods trade;capital flight;domestic currencies;debt service;domestic money;fixed rate;real capital;asset holder;real wage;adjustment process;basic rate;financial disturbance;deficit finance;capital gain;initial equilibrium;domestic asset;uniform rate;

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Citation

Dornbusch, Rudiger

Special exchange rates for capital account transactions (English). Washington, D.C. : World Bank Group. http://documents.worldbank.org/curated/en/900691468764418704/Special-exchange-rates-for-capital-account-transactions