Abstract
In emerging market economies, under-development of financial markets leads to goods hoarding and foreign currency accumulation as forms of investment. In this paper an asset market model, supplemented by explicit treatment of smuggling and second-economy activity, is used to study the paths of black-market exchange rates, second-economy prices, hoarding stocks, and privately held dollar balances following policy reforms. We discuss conditions for overshooting and related dynamics of exchange rates and prices following: official exchange-rate adjustments, price reforms, and altered risks of monetary confiscation or currency reforms. The saddlepath trajectory of financial adjustment is simulated using data from recent Russian experience. © 1997 Elsevier Science B.V.
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