THE MACROECONOMICS OF DELAYED EXCHANGE RATE UNIFICATION: THEORY AND EVIDENCE FROM TANZANIA

Daniel Kaufmann and Stephen O'Connell

No 294377, Harvard Institute for International Development (HIID) Papers from Harvard University, Kennedy School of Government

Abstract: Parallel exchange rate markets have often been dismissed by authorities as a nuisance or as the domain of a small group of economic saboteurs. Taking Tanzania as a case study, we argue instead that such a market played a central macroeconomic role throughout the seventies and eighties. We provide a rigorous macro-economic analysis of the parallel foreign exchange market and its fiscal implications. First, the evolution of the parallel foreign exchange market in Tanzania from the mid-1960s to 1990 is investigated. This period stretches from the adoption of exchange controls to the macroeconomic collapse and subsequent reforms in the mid-to-late 1980s. A reduced form econometric equation (of a Dornbush stock-flow model type) indicates that both trade and financial portfolio factors were important in determining the parallel premium, with trade determinants dominating in the long run, as suggested by theory. In the second part of the paper, we investigate the fiscal impact of the parallel exchange rate premium, an issue emphasized in the literature on exchange-rate unification. We construct a counter-factual simulation of fiscal and balance-of-payments flows under alternative assumptions regarding the indexation of these flows to the parallel and official exchange rate. We find that a more aggressive move towards exchange rate unification would have already delivered a fiscal bonus by the mid-1980s. Accordingly, a unification of the exchange rate would have reduced monetary growth and inflationary pressures. Thus, contrary to conventional advice in much of Africa and other countries, the case of Tanzania illustrates that even from a purely fiscal implication standpoint there was no economic rationale for delaying a move towards convertibility.

Keywords: International; Development (search for similar items in EconPapers)
Pages: 41
Date: 1996-11
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Persistent link: https://EconPapers.repec.org/RePEc:ags:hariid:294377

DOI: 10.22004/ag.econ.294377

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