Adjustment to monetary policy and devaluation under two-tier and fixed exchange rate regimes

The purpose of this paper is to determine whether a two-tier exchange rate regime is more effective than a fixed rate regime in increasing a country's ability to pursue an independent monetary policy. The analysis compares adjustment to a monetary policy and to a devaluation in the two exchange rate regimes in a portfolio model under imperfect assets substitutability. It is shown that a two-tier exchange rate regime is capable of reducing the current account effects of monetary injection or devaluation only in the long run. In the short run, however, we can get a larger current account response under a two-tier regime. These results reflect the trade-off between quantity and price adjustment.