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Optimal Currency Basket Pegs for Developing and Emerging Economies

Author

Listed:
  • P. Daniels, Joseph

    (Marquette University)

Abstract
The exchange rate arrangement represents an important policy choice for emerging and transitional economies as they strive to become stable and marketdriven. 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 smallcountry macroeconomic 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.

Suggested Citation

  • 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.
    • Handle: RePEc:ris:integr:0157
    as

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    References listed on IDEAS

    as
    1. Sachs, Jeffrey D, 1996. "Economic Transition and the Exchange-Rate Regime," American Economic Review, American Economic Association, vol. 86(2), pages 147-152, May.
    2. 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.
    3. 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.
    4. 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.
    5. Guy Debelle & Mr. Miguel A Savastano & Mr. Paul R Masson & Mr. Sunil Sharma, 1998. "Inflation Targeting as a Framework for Monetary Policy," IMF Economic Issues 1998/005, International Monetary Fund.
    6. 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.
    7. 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.
    8. Daniels, Joseph, 1997. "Optimal sterilization policies in interdependent economies," Journal of Economics and Business, Elsevier, vol. 49(1), pages 43-60, February.
    9. Kotilainen, Markku, . "Exchange Rate Unions: A Comparison with Currency Basket and Floating Rate Regimes," ETLA A, The Research Institute of the Finnish Economy, number 21, June.
    10. repec:bla:scandj:v:92:y:1990:i:4:p:559-71 is not listed on IDEAS
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    Cited by:

    1. Zhang, Zhichao & Shi, Nan & Zhang, Xiaoli, 2011. "China’s new exchange rate regime, optimal basket currency and currency diversification," MPRA Paper 32642, University Library of Munich, Germany.
    2. Habib, Maurizio Michael & Stráský, Jan, 2008. "Oil exporters: in search of an external anchor," Working Paper Series 958, European Central Bank.
    3. Zhang, Zhichao & Shi, Nan & Zhang, Xiaoli, 2011. "China s new exchange rate regime, optimal basket currency and currency diversification," BOFIT Discussion Papers 19/2011, Bank of Finland Institute for Emerging Economies (BOFIT).
    4. Zhang, Zhichao & Shi, Nan & Zhang, Xiaoli, 2011. "China’s new exchange rate regime, optimal basket currency and currency diversification," MPRA Paper 32642, University Library of Munich, Germany.
    5. repec:zbw:bofitp:2011_019 is not listed on IDEAS

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    More about this item

    Keywords

    Optimal; Currency; Basket;
    All these keywords.

    JEL classification:

    • F30 - International Economics - - International Finance - - - General
    • P50 - Political Economy and Comparative Economic Systems - - Comparative Economic Systems - - - General

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