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Should small open economies in East Asia put all their eggs in one basket: the role of balance sheet effects

  • Slavi T. Slavov

    (Pomona College)

Yen-dollar fluctuations increase macroeconomic instability in small economies in East Asia. I investigate the choice of an exchange rate regime for these countries so as to minimize the adverse effects of this volatility. I build a sticky-price dynamic model of a small economy whose trade is invoiced in dollar and yen. First, I show the conditions under which pegging to a tradeweighted basket of the two currencies is the optimal policy for the small economy. Then, I introduce net worth constraints and unhedged dollar borrowing which pull the optimal policy away toward putting a much greater weight on the dollar.

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File URL: http://econwpa.repec.org/eps/if/papers/0501/0501001.pdf
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Paper provided by EconWPA in its series International Finance with number 0501001.

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Length: 35 pages
Date of creation: 12 Jan 2005
Date of revision:
Handle: RePEc:wpa:wuwpif:0501001
Note: Type of Document - pdf; pages: 35
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Yun, Tack, 1996. "Nominal price rigidity, money supply endogeneity, and business cycles," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 345-370, April.
  2. Andrew Berg & Paolo Mauro & Michael Mussa & Alexander K. Swoboda & Esteban Jadresic & Paul R Masson, 2000. "Exchange Rate Regimes in an Increasingly Integrated World Economy," IMF Occasional Papers 193, International Monetary Fund.
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  11. Michael B. Devereux & Philip R. Lane & Juanyi Xu, 2006. "Exchange Rates and Monetary Policy in Emerging Market Economies," Economic Journal, Royal Economic Society, vol. 116(511), pages 478-506, 04.
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  16. Jordi Galí & Tommaso Monacelli, 2004. "Monetary policy and exchange rate volatility in a small open economy," Economics Working Papers 835, Department of Economics and Business, Universitat Pompeu Fabra.
  17. Ronald McKinnon & Gunther Schnabl, 2002. "Synchronized Business Cycles in East Asia: Fluctuations in the Yen/Dollar Exchange Rate and China’s Stabilizing Role," Working Papers 02010, Stanford University, Department of Economics.
  18. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange Rates and Financial Fragility," NBER Working Papers 7418, National Bureau of Economic Research, Inc.
  19. Turnovsky, Stephen J., 1982. "A determination of the optimal currency basket : A macroeconomic analysis," Journal of International Economics, Elsevier, vol. 12(3-4), pages 333-354, May.
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