This paper applies the autoregressive distributed lag approach to cointegration analysis in estimating the 'virtual exchange rate' (VER) in India. The VER would have prevailed if the unconstrained import demand were equal to the constraint imposed due to foreign exchange rationing and the VER is used to approximate the 'price' of rationed foreign exchange reserves. We highlight the shortcomings of the existing literature in approximating equilibrium exchange rates in a less developed country such as India and propose the VER approach for equilibrium rates, which uses information from an estimated structural model. In this relationship, black market real exchange rate (E U ) is a dependent variable and real official exchange rates (E O ), the ratio of the foreign (r*) to the domestic (r) interest rate (I), and official forex reserves (Q) are explanatory variables. In our estimation, the VERs are higher than E O by about 10% in the short-run and 16% in the long-run.

The use of the ARDL approach in estimating virtual exchange rates in India

The authors review the theoretical literature on the determinants of international workers' remittances and then posit an empirical model that accounts for demographic, portfolio, and macroeconomic factors that - together with special incentive policies - determine official remittances. They estimated the model using data from five major labor-exporting countries of North Africa and Europe: Morocco, Portugal, Tunisia, Turkey, and the former Yugoslavia. The econometric results strongly corroborate the model's predictions and reveal interesting policy implications. In planning for the future growth of remittances, labor-exporting countries should explicitly take into consideration the history of migration, since an aging labor force abroad will be less inclined to remit. Labor-exporting countries should also account for the economic prospects of the major labor-receiving countries and for the geographical distribution of their migrant labor. The authors' results show that remittances are significantly affected by economic policies in the home (labor-exporting) countries. Special incentive schemes cannot substitute for a stable, credible macroeconomic policy.

Determinants of expatriate workers' remittances in North Africa and Europe

Dual exchange rates and black markets for foreign exchange are common in developing countries, and a body of evidence is beginning to emerge on the effects that such parallel foreign exchange systems have on macroeconomic performance. This article presents a simple typology of parallel systems, discusses their emergence, and looks at why countries prefer these arrangements to the main alternatives. The article examines the ability of parallel markets to insulate international reserves and domestic prices from shocks to the balance of payments. Drawing on the findings from eight detailed case studies, the authors discuss the determination of the parallel premium in the short and long terms, the relationship between the premium and illegal transactions, and the fiscal effects of parallel rates. They compare the experiences of countries that have attempted to unify their foreign exchange markets and discuss the implications for policy alternatives.

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Parallel exchange rates in developing countries

Publisher Summary This chapter reviews the international aspects of monetary policy and presents the classical model of the open economy. The operation of the gold standard, the price–specie flow mechanism, purchasing power parity, and the monetary approach to the balance of payments are illustrated in the chapter. The Mundell–Fleming model that is an open economy version of the investment—saving/liquidity preference—money supply (IS–LM) model of monetary policy under conditions of short-run wage–price stickiness and capital mobility are discussed in the chapter. The distinction between fixed and flexible exchange rates is described in the chapter. The macroeconomic model is described in the chapter by drawing out the evidence on two central questions: the extent to which wages and prices are sticky and the international linkages among asset markets. Both issues are of central importance for the channels of transmission and the effectiveness of monetary policy. Classical monetary economics deals with the linkages among money, spending, and prices in the open economy. It is best represented by David Hume's price–specie flow mechanism. The simple model assumes full price flexibility and focuses on a money–goods economy with no nonmonetary assets.

Chapter 23 Monetary policy in the open economy

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.

Special Exchange Rates for Capital Account Transactions

The model of the black market for dollars focuses on the interaction of portfolio decisions relevant to the holding of asset stocks and the determinants of net flows of dollars associated with tourism and smuggling. A partial-equilibrium model of the black market shows that the level of the premium is determined by the official real exchange rate and the official, depreciation-adjusted interest differential, as well as seasonal factors associated with tourism. Expectations of future exchange rate changes, under rational expectations, are shown to affect the current level of the black market premium. The empirical evidence provides ample support for the role of the key determinants of the premium as well as for an important seasonal pattern. The magnitude of the seasonal variation is evidence of the imperfect substitutability between black dollars and cruzeiro assets in portfolios.

Roberto de Rezende Rocha

Papers

The Black Market for Dollars in Brazil