The Optimal Currency Basket with Input Currency and Output Currency

27 Pages Posted: 8 Jan 2009

See all articles by Kang Shi

Kang Shi

The Chinese University of Hong Kong (CUHK) - Department of Economics

Juanyi (Jenny) Xu

Hong Kong University of Science & Technology (HKUST); Simon Fraser University (SFU); Hong Kong University of Science & Technology (HKUST) - Department of Economics

Date Written: September 30, 2008

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

JEL Classification: F3, F4

Suggested Citation

Shi, Kang and Xu, Juanyi (Jenny), The Optimal Currency Basket with Input Currency and Output Currency (September 30, 2008). Hong Kong Institute for Monetary and Financial Research (HKIMR) Research Paper WP No. 17/2008, Available at SSRN: https://ssrn.com/abstract=1323621 or http://dx.doi.org/10.2139/ssrn.1323621

Kang Shi (Contact Author)

The Chinese University of Hong Kong (CUHK) - Department of Economics ( email )

Shatin, N.T.
Hong Kong

Juanyi (Jenny) Xu

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

Simon Fraser University (SFU)

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Clear Water Bay
Kowloon, Hong Kong
China

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