Optimal Currency Basket Pegs for Developing and Emerging Economies
The 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.
|Date of creation:||Mar 2001|
|Date of revision:|
|Publication status:||Published in Journal of Economic Integration, March 2001, pages 128-145|
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- Jeffrey A. Frankel, 1999. "No Single Currency Regime is Right for All Countries or At All Times," NBER Working Papers 7338, National Bureau of Economic Research, Inc.
- Daniels, Joseph P & VanHoose, David D, 1999. "The Nonstationarity of Money and Prices in Interdependent Economies," Review of International Economics, Wiley Blackwell, vol. 7(1), pages 87-101, February.
- Guy Debelle & Miguel A. Savastano & Paul R. Masson & Sunil Sharma, 1998. "Inflation Targeting as a Framework for Monetary Policy," IMF Economic Issues 15, International Monetary Fund.
- Daniels, Joseph, 1997. "Optimal sterilization policies in interdependent economies," Journal of Economics and Business, Elsevier, vol. 49(1), pages 43-60, February.
- Benassy-Quere, Agnes, 1999. "Optimal Pegs for East Asian Currencies," Journal of the Japanese and International Economies, Elsevier, vol. 13(1), pages 44-60, March.
- Edison, Hali J & Vardal, Erling, 1990. " Optimal Currency Baskets for Small, Developed Economies," Scandinavian Journal of Economics, Wiley Blackwell, vol. 92(4), pages 559-71.
- Girardin, Eric & Marimoutou, Velayoudom, 1997. "Estimating the credibility of an exchange rate target zone," Journal of International Money and Finance, Elsevier, vol. 16(6), pages 931-944, December.
- Sachs, Jeffrey D, 1996. "Economic Transition and the Exchange-Rate Regime," American Economic Review, American Economic Association, vol. 86(2), pages 147-52, May.
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