Title: Dynamic analysis of dual exchange rates in small open economy

Authors: Ibrahim A. Onour

Addresses: Arab Planning Institute, P.O. Box 5834, Safat, Kuwait

Abstract: Using a model of a small open economy operating under dual foreign exchange markets, free exchange rate for financial transactions and quasi-fixed exchange rate for commercial transactions, this paper analyses the dynamic adjustment of the foreign exchange rates, when terms of trade, and monetary disturbance shocks hit the economy. The results indicate that under such a dual foreign exchange system, the stability of a foreign exchange system requires a sufficient level of official reserves that can accommodate adverse terms of trade and monetary disturbance shocks. Under insufficient reserves, adverse shocks can lead to official reserve depletion and exchange rates divergence.

Keywords: financial rate; commercial rate; stability; steady-state; open economies; small economies; economic policy; emerging economies; foreign exchange rates; dual foreign exchange markets; trade disturbance; monetary disturbance; official reserves.

DOI: 10.1504/IJEPEE.2009.022940

International Journal of Economic Policy in Emerging Economies, 2009 Vol.2 No.1, pp.50 - 62

Published online: 04 Feb 2009 *

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