Capital controls, hidden capital flows and exchange rate determination

This dissertation provides a general equilibrium analysis of the interaction between capital controls, commercial exchange controls, and smuggling. A model of capital controls is developed in which the parallel or black market exchange rate premium is determined in a portfolio balance equilibrium setting. While the premium is determined in the short run by international and domestic financial conditions, its stationary state value is determined in a well-defined manner by commercial exchange control policy. Deviations of the premium from its stationary state value precipitate covert capital flows which tend to drive the premium back towards its stationary state value. The dissertation examines the dynamics of the adjustment process as well as the implications of exchange controls and covert capital flows for economic policy. The empirical analysis of the dissertation provides estimates of the marginal impact of the dual exchange rate premium on the magnitude of covert capital flows in the dual exchange rate system of the Belgium-Luxembourg Economic Union. Empirical support is found for the contention that leakages were both statistically and economically significant during the period examined.