ABSTRACT
This chapter develops a model of black market premiums. This model uses both political and economic variables, because neither can be isolated from the other. The chapter proposes to identify constraints on the supply of foreign exchange reserves, which governments use as reasons to intervene in foreign exchange markets. It also proposes to investigate the effect of politics on premiums. The chapter evaluates the power of politics and economics to explain premiums when governments are effective and when they are ineffective. It argues that an efficient government fosters an environment of certainty and trust in its ability to implement the necessary macroeconomic adjustments in the economy to preclude the rise of a black market in hard currency. Relative political capacity is used as a proxy for government efficiency. The main hypothesis of the chapter is that political variables are a strong, thus far neglected determinant of black market premiums.
