The Optimal Currency Basket with Input Currency and Output Currency

Kang Shi and Juanyi Xu
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Kang Shi: The Chinese University of Hong Kong
Juanyi Xu: Hong Kong University of Science and Technology

No 172008, Working Papers from Hong Kong Institute for Monetary Research

Abstract: This paper explores the determination of the optimal currency basket in a small open economy general equilibrium model with sticky prices. In contrast to traditional literature, we focus on an economy with vertical trade, where one currency is used as the invoicing currency of imported intermediate goods and is called the "input currency", while the other currency is used for the invoicing of exported finished goods and is called the "output currency". We find that in the optimal currency basket the weight between the input currency and the output currency depends critically on the structure of vertical trade. Moreover, we show that if a country decides to choose a single-currency peg, then the choice of pegging currency depends mainly on how other economies respond to external exchange rate fluctuations. In a sense, our paper provides a case for the Chinese RMB peg in some East Asian economies, given the importance of the RMB as an input currency.

Keywords: Input Currency; Output Currency; Currency Basket Peg; Welfare (search for similar items in EconPapers)
JEL-codes: F3 F4 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2008-09
New Economics Papers: this item is included in nep-cba, nep-mon, nep-opm and nep-sea
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Citations: View citations in EconPapers (1)

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