Currency Inconvertibility, Portfolio Balance and Relative Prices
This paper analyzes regimes of currency inconvertibility in the frame-work of a simple general equilibrium model where an officially-traded good,a smuggled good and a non-traded good are produced and consumed by residents,who hold domestic and foreign currency in their portfolios. It is shown that stability requires the effect of relative prices on demand for traded and non-traded goods to dominate their effect on asset demands and that a once-and-for-all devaluation does not change the currency substitution ratio.To the extent that the monetary authorities wish to change the currency composition of private financial wealth, a crawling peg is therefore the appropriate instrument. The direction of change depends on the nature of expectations about relative asset returns. Under perfect foresight, an increase in the rate of crawl increases the currency substitution ratio whereas, if expectations are static, it reduces it.
Document Object Identifier (DOI): 10.3386/w1087
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