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The optimal currency basket under vertical trade

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  • Xu, Juanyi

Abstract

This paper explores the theory of optimal currency basket in a small open economy general equilibrium model with sticky prices. In contrast to existing literature, we focus on an economy with vertical trade, where the currencies in the basket may play different roles in invoicing trade flow. In a simple two-currency basket, one currency is used to invoice imported intermediate goods and is called “import currency”, while the other currency is used to invoice exported finished goods and is called “export currency”. We find that the optimal weights of the import currency and the export currency depends critically on the structure of vertical trade. Moreover, if a country decides to choose a single-currency peg, the choice of pegging currency also depends on how other competing economies respond to external exchange rate fluctuations.

Suggested Citation

  • Xu, Juanyi, 2011. "The optimal currency basket under vertical trade," Journal of International Money and Finance, Elsevier, vol. 30(7), pages 1323-1340.
    • Handle: RePEc:eee:jimfin:v:30:y:2011:i:7:p:1323-1340
    DOI: 10.1016/j.jimonfin.2011.07.002
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    More about this item

    Keywords

    Vertical trade; Import currency; Export currency; Currency basket peg; Welfare;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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