Dual exchange rates are an economic concept in which a currency has two different values in monetary transactions. This can cause a significant difference in prices. In an attempt to reduce the costs of international trade, many countries have introduced dual exchange rates to their currency systems. These dual rates can make international transactions more convenient for businesses.
However, these systems are not without their drawbacks. First, dual exchange rates are subject to manipulation and can lead to rent-seeking behavior. Second, DMERs can result in substantial damage to the economy if they are not handled properly. Thus, these systems must be treated with extreme caution. Even if they may appear to be a viable option, they should be treated as transitional measures.
A dual exchange rate system allows for the use of both a floating and fixed exchange rate. Some transactions are reserved for the fixed exchange rate, such as exports and imports. Others, such as capital account transactions, may be determined by a market-driven exchange rate. In this way, dual exchange rates can help governments avoid foreign currency inflation and lessen pressure on foreign reserves. In addition, they allow governments to control foreign currency transactions.
A dual exchange rate system can help a country stabilize its currency during an economic crisis. The government usually sets one official rate and a separate, floating rate, which is often determined by the market. The dual exchange rate system can help prevent currency devaluation, but also leads to higher volatility in market dynamics. In addition to being a temporary fix, dual exchange rates may also lead to black-market trading.
While the dual exchange rate system has many benefits, it has also drawn criticism from academic researchers. Some researchers argue that it fails to protect domestic prices. In practice, these systems often lead to more transactions shifting to the parallel exchange rate, which depreciates compared to the official rate. This is a major concern because the parallel market is not always transparent.
Bilateral exchange rates are the most common type of exchange rate. They are quoted against one another and are commonly used as a benchmark. For example, the euro against the US dollar is known as the EUR/USD, while the Australian dollar is known as AUD/USD. Using the EUR/USD and AUD/USD rates, you can find out how much the euro is worth in each country.
Parallel market exchange rates can be defined as stable, unstable, or thin. The parallel market exchange rate is typically 30-40% weaker than the official exchange rate, indicating insufficient supply and uncertainty about policy decisions. The parallel market exchange rate will feed into the official exchange rate if credible changes in fiscal and monetary policy are made.