Optimal Currency Basket Pegs for Developing and Emerging Economies
AbstractThe exchange rate arrangement represents an important policy choice for emerging and transitional economies as they strive to become stable and market-driven. A wide variety of arrangements have emerged, ranging from currency boards, basket-currency pegs and single-currency pegs to floating rates. Recently the IMF has recommended that, if the exchange value of a currency is to be pegged, it is better to peg to a basket of currencies rather than a single currency. Nonetheless, there has been little theoretical research on the management and optimal design of basket-peg arrangements. In this paper we extend the small-country macroeconomics model of Turnovsky to show that an optimally designed basket-peg arrangement can minimize the variance in domestic consumer prices as well as the variance of foreign reserves. The model highlights the importance of the money and bond markets and, therefore, the importance of various interest rate channels. Additionally we show that a trade-weighted currency basket is not only suboptimal, it is at odds with increasing capital market integration. Further our solutions illustrate that the optimal weights will evolve as the domestic economy integrates with the global market for goods and services, and financial instruments.
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Bibliographic InfoPaper provided by Marquette University, Center for Global and Economic Studies and Department of Economics in its series Working Papers and Research with number 0103.
Length: 18 pages
Date of creation: Mar 2001
Date of revision:
Publication status: Published in Journal of Economic Integration, March 2001, pages 128-145
exchange rate regimes; basket pegs;
Other versions of this item:
- P. Daniels, Joseph, 2001. "Optimal Currency Basket Pegs for Developing and Emerging Economies," Journal of Economic Integration, Center for Economic Integration, Sejong University, vol. 16, pages 128-145.
- F3 - International Economics - - International Finance
- P5 - Economic Systems - - Comparative Economic Systems
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