OPTIMAL MONETARY AND EXCHANGE-RATE POLICY WITH A 2-TIER EXCHANGE-RATE

A two-tier (or dual) exchange rate system, with one rate for current account transactions and another for capital account transactions, has been shown in previous studies to provide a degree of insulation from the effects of international capital flows. In this paper we investigate the optimal setting and coordination of monetary and foreign exchange market intervention rules in such a two-tier exchange rate regime. The two-tier exchange rate system is shown to significantly enhance the effectiveness of stabilization policy in a world of perfect capital mobility.