Essays on Currency Competition, Institutional Restrictions and Exchange Rates
This dissertation consists of three essays on currency competition, institutional restrictions and exchange rates.
When faced with currency competition, a country's government has two tools at its disposal: reduce the level of inflation or place institutional barriers to the use of foreign currency. In the first chapter, I propose a two-country, two-currency New Monetarist model to study currency competition. I model institutional barriers as a `tax' on the real value of foreign currency holdings which tends to lower a currency's value abroad than at home. This tax-induced asymmetric valuation of currencies leads to a set of rich and unique equilibrium currency regimes thus overcoming the multiplicity of equilibrium often noticed in models of currency competition.
In the second chapter, I examine whether capital controls as well as restrictions on financial current account in certain emerging market economies had any effect in providing buoyancy to its domestic currency. Using a country-by-country SVAR approach for five emerging market economies -- Chile, Colombia, India, Malaysia and Indonesia for the time period of 1970-2013 and then using a panel VAR approach, I find that there is a role for such restrictions in affecting the nominal exchange rate. However, such effects are limited to the short-run and their effectiveness vary by country.
In the third chapter, I propose a tractable model of the black market for currencies where the black market premium on foreign currency arises endogenously and depends on the relative inflation rates of domestic and foreign currencies. Using a New Monetarist framework, I offer a plausible explanation as to why this association could be sometimes positive and sometimes negative. The black market is modeled as a market that can be used by buyers to readjust their portfolio when access to the official market is infrequent and after the realization of a shock that forces them to either consume local or foreign goods. After allowing for currency substitution by agents, in the stationary monetary equilibrium the rate of black market premium could be decreasing in the domestic inflation rate if agents are not very risk averse. Else, the black market premium is increasing in domestic inflation.