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Black Market Exchange Rate, Unification of the Foreign- Exchange Markets and Monetary Policy

The Case of El Salvador

Series:

Nolvia N. Saca

This study examines theoretically as well as empirically the behavior of a small open economy, first, under a dual official-black market exchange rate regime, and then, under the process of unification that has as its ultimate objective to absorb and legalize the black market for foreign exchange, eliminating the inefficiencies and market fragmentation associated with quasi-illegal activities. The study provides a modest insight into the difficulties of maintaining a system of dual exchange rates, on the one hand, and into the problems that a central bank may face in the conduct of monetary policy in the context of exchange rate and financial liberalization, on the other hand. It should also serve as a basis and motivation for continuing work on the design of the appropriate strategy of monetary policy for El Salvador. Additionally, it could serve as a guide for many developing countries which have a sizable black market and consider the unification of foreign exchange markets an important policy objective.
Contents: Determinants of the premium in the black market - Effect of the black market on the domestic price level and on the real exchange rate - Issues that the authorities have to face in considering unification of the foreign exchange markets - Monetary effects and implications for the conduct of monetary policy with the resulting changes in the exchange rate policy and financial and trade structure.