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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. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
  2. Andrew Crockett & Chairman, 1999. "General discussion : exchange rates and financial fragility," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 411-422.
  3. Wei, S.J. & Frankel, J.A., 1992. "Yen Bloc or Dollar Bloc: Exchange Rate Policies of the East Asian Economies," Papers 92-08, University of Birmingham - International Financial Group.
  4. 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.
  5. Engel, C., 1996. "Accounting for U.S. Real Exchange Rate Changes," Working Papers 96-02, University of Washington, Department of Economics.
  6. Luis Felipe Cespedes & Roberto Chang & Andres Velasco, 2000. "Balance Sheets and Exchange Rate Policy," NBER Working Papers 7840, National Bureau of Economic Research, Inc.
  7. Philip R. Lane & Michael B. Devereux,Juanyi Xu, 2005. "Exchange Rates and Monetary Policy in Emerging Market Economies," The Institute for International Integration Studies Discussion Paper Series iiisdp036, IIIS.
  8. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  9. Takatoshi Ito & Eiji Ogawa & Yuri Nagataki Sasaki, 1999. "How Did the Dollar Peg Fail in Asia?," NBER Working Papers 6729, National Bureau of Economic Research, Inc.
  10. 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.
  11. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  12. Barry Eichengreen & Ricardo Hausmann, 1999. "Exchange Rates and Financial Fragility," NBER Working Papers 7418, National Bureau of Economic Research, Inc.
  13. Frankel, Jeffrey & Rose, Andrew K., 2001. "An Estimate of the Effect of Common Currencies on Trade and Income," Working Paper Series rwp01-013, Harvard University, John F. Kennedy School of Government.
  14. Blanchard, Olivier Jean & Kahn, Charles M, 1980. "The Solution of Linear Difference Models under Rational Expectations," Econometrica, Econometric Society, vol. 48(5), pages 1305-11, July.
  15. Jordi Gali & Tommaso Monacelli, 2002. "Monetary Policy and Exchange Rate Volatility in a Small Open Economy," NBER Working Papers 8905, National Bureau of Economic Research, Inc.
  16. 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.
  17. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
  18. 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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