Dual Exchange-rates Under Pegged Interest-rate and Balance-of-payments Crisis

This paper develops a model of dual exchange rates and pegged interest rate. It shows that under perfect asset substitutability, the financial exchange rate dynamics is unrelated to current-account imbalances. It also demonstrates that, if the emergence of a current account deficit is expected to give rise to a devaluation of the commercial exchange rate, there will be an instantaneous depreciation of the financial exchange rate and further depreciation along the adjustment path. This is in sharp contrast to the established result that under dual rates a current account deficit is associated with an appreciating financial rate. (JEL E52, F31).