Foreign Exchange Controls and the Parallel Market Premium

This paper studies the relationship between the official and parallel exchange rates, using cointegration, Granger causality, and reduced form methods on data from three Caribbean countries, Jamaica, Guyana, and Trinidad & Tobago, for the period 1985–93. Where the central bank follows a passive policy of infrequent and large adjustments to the official rate, changes in the official rate Granger causes changes in the parallel rate, and larger disparities prevail between the two rates. Foreign exchange controls, expansionary fiscal and monetary policy, and changes of government mostly have a positive effect on the parallel market premium, with foreign exchange controls exerting the strongest impact.