Exchange Rate Dynamics under Dual Exchange Rates: The Case of Neutral Intervention Policy.

By considering an economy in which there are traded and nontraded goods, wealth is held in the form of domestic money, bonds, or foreign bonds, and the foreign exchange market is of the dual rates regime with neutral intervention by the authorities, this paper shows that the financial exchange rate first undershoots and then approaches its long-run equilibrium monotonically following anticipated or unanticipated changes in money supply. Its movement can therefore be said to be more stable than that under the ordinary dual rates system without intervention, if the absence of overshooting is taken as a criterion of relative stability. Copyright 1989 by Blackwell Publishers Ltd and The Victoria University of Manchester