The macroeconomics of delayed exchange-rate unification: theory and evidence from Tanzania

Daniel Kaufmann and Stephen O'Connell ()

No 2060, Policy Research Working Paper Series from The World Bank

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. Using Tanzania as a case study, the authors argue instead that these markets played a central macroeconomicrole in the 1970s and 1980s. They provide a rigorous macroeconomic analysis of the parallel foreign-exchange market and its fiscal implications. First, they investigate the evolution of that market in Tanzania from the mid-1960s to 1990. That period stretched from the adoption of exchange controls to macroeconomic collapse and then to subsequent reforms in the mid- to late 1980s. A reduced -form econometric equation (of a Dornbusch stock-flow model type) indicates that both trade and financial portfolio factors were important in determining the parallel premium, with trade determinants the parallel premium, with trade determinants dominating in the long run, as theory suggests. Then they investigate the fiscal impact of the parallel exchange-rate premium, an issue emphasized in the literature on exchange-rate unification. They construct a counterfactual simulation of fiscal and balance-of-payments flows under alternative assumptions about the indexing of those flows to the parallel and official exchange rate. They find that a more aggressive move toward exchange-rate unification would have already delivered a fiscal bonus by the mid-1980s. Accordingly, unification of the exchange rate would have reduced monetary growth and inflationary pressures. So, contrary to conventional advice often given in Africa and elsewhere, the case of Tanzania suggests that from a fiscal viewpoint there was no economic rationale for gradualism in exchange-rate unification and delay of a move toward convertibility.

Keywords: Economic Theory&Research; Banks&Banking Reform; Fiscal&Monetary Policy; Payment Systems&Infrastructure; Environmental Economics&Policies; Economic Theory&Research; Macroeconomic Management; Fiscal&Monetary Policy; Environmental Economics&Policies; Economic Stabilization (search for similar items in EconPapers)
Date: 1999-02-28
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Citations: View citations in EconPapers (2)

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Related works:
Working Paper: THE MACROECONOMICS OF DELAYED EXCHANGE RATE UNIFICATION: THEORY AND EVIDENCE FROM TANZANIA (1996)
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