Unification of dual exchange markets

Abstract

This paper develops the model of an economy under a dual exchange system, comprising an official market with a crawling exchange rate and a free market with a floating exchange rate. After analyzing the behavior of the economy under the dual system, the paper discusses the effects that switching to a unified floating system or a unified crawling peg system has on the exchange rate and on the balance of payments, particularly in the short run. The paper shows that these effects depend on the composition of the private sector's portfolio at the time of unification, which, in turn, depends on the various policies that were followed while the economy was under the dual system. © 1987.