Unification of Foreign Exchange Markets: A Comment on Agenor and Flood

Abstract

Recently in an interesting paper in IMF Staff Papers, Pierre-Richard Agenor and Robert Flood (1992) set up a theoretical model of dual exchange rates and analyzed how the economy would work given the shock of an announcement to unify dual exchange markets. Provided that the unified exchange rate under the flexible regime is greater than the official exchange rate under the dual regime, their major findings are (i) at the announcement, the domestic price of foreign currency in the parallel exchange market depreciates immediately, (ii) the parallel exchange rate keeps rising and net foreign assets keep falling during the pre-unification period, and (iii) the unified exchange rate of the post-unification regime is independent of the timing of unified implementation. This paper is written for two purposes. First, we intend to show that the unified exchange rate of the post-reform regime is inversely related to the date of reform. Second, we attempt to extend the graphical presentation of Agenor and Flood (1992) and to trace the possible dynamic behavior of relevant variables during the unified process.1