ABSTRACT
This chapter describes capital mobility and exchange-rate policy in Colombia in an effort to examine the elements of the puzzle. It examines trade exposure, Gross domestic product, and financial intermediation, which can help explain the persistence of pegging in other states but not in Colombia. The chapter examines the three factors: illegal capital flows, the crawling band, and foreign exchange reserves, which do explain its ability to avoid hollowing-out pressures until 1994. It examines the political foundations underlying exchange-rate policy in Colombia. The chapter also examines how Colombia moved from a crawling peg that gradually devalued the peso to a crawling band regime that let the peso appreciate, and how the crawling band eventually fell apart. In Peru the financial system was less developed and politicians faced less resistance in introducing a floating exchange rate. But many developing countries have small banking sectors and yet have pegged for a substantial time.
