Should East Asia's Currencies Be Pegged to the Yen? The Role of Pricing Behavior and Currency Invoicing
I develop a three-country center-periphery sticky-price general equilibrium model to study alternative exchange rate regimes for East Asian economies. The model is evaluated under two price-setting specifications: producer currency pricing (PCP) and dollar standard, a specification where export prices are set in the dollar, designed to capture the prevalence of dollar invoicing in East Asia. Consumer's utility is chosen as the welfare criterion. The surprising result is that under dollar standard, pegging to the yen alone dominates both a currency basket regime and pegging to the dollar for empirically relevant parameters. This stands in stark contrast to the case of PCP, where a currency basket regime dominates a fixed exchange rate regime. These results point to the importance of taking into consideration pricing behavior in designing optimal currency basket. However, flexible exchange rate regime is the optimal exchange rate regime under both price-setting specifications
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