The issue of determining inter-market foreign exchange flows under dual exchange markets has been hotly debated. Typically the literature has concentrated on the behavior of the financial premium, leaving aside equally important aspects such the reasons for and characteristics of incomplete separation. Our analytical results suggest that cross transactions arise as long as the government changes the commercial rate. Time inconsistency of policy brings opportunity for leakages between two markets. We also find that the more patient the government, the less likely the occurrence of commercial depreciation and leakages will be. Then reputation could be as a deterrent to leakages
Previous literature believes that a commercial depreciation is associated with higher financial premium and more depletion of foreign reserves. This study re-investigates this belief. Analytical results indicate that a commercial depreciation with higher financial premium and more depletion of foreign reserves depend on the combined influences of the conditions that individuals are impatient as well as foreign interest rates are bigger than time preference rates rather than only policies of commercial depreciation. Non-distortion taxation does not solve the balance-of-payments difficulties. An exact negative relationship between foreign reserves and the financial premium cannot be found.
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