The Currency-Plus-Commodity Basket: A Proposal for Exchange Rates in Oil-Exporting Countries to Accommodate Trade Shocks Automatically

36 Pages Posted: 25 Aug 2017

See all articles by Jeffrey A. Frankel

Jeffrey A. Frankel

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

Date Written: April 2017

Abstract

The paper proposes an exchange rate regime for oil-exporting countries. The arrangement is designed to achieve the best of both flexible and fixed exchange rates: to deliver monetary policy that counteracts rather than exacerbates the effects of swings in the oil market, while yet offering the day-to-day transparency and predictability of a currency peg. The proposal is called Currency-plus-Commodity Basket (CCB). The plan is to peg the national currency to a basket, but a basket that includes not only the currencies of major trading partners (in particular, the dollar and the euro), but also the export commodity (oil). The paper begins by fleshing out the need for an innovative arrangement that allows accommodation to trade shocks. The analysis provides evidence from six Gulf countries that periods when their currencies were “undervalued”, in the sense that the actual foreign exchange value lay below what it would have been under the CCB proposal, were periods of overheating as reflected in high inflation and of external imbalance as reflected in high balance of payments surpluses. Conversely, periods when the currencies were “overvalued,” in the sense that their foreign exchange value lay above what it would have been under CCB, featured unusually low inflation and low balance of payments. These results are suggestive of the implication that the economy would have been more stable under CCB. The last section of the paper offers a practical blueprint for detailed implementation of the proposal.

Keywords: basket, commodities, currency, exchange rate, Gulf, oil, peg, Saudi Arabia

JEL Classification: F3

Suggested Citation

Frankel, Jeffrey A., The Currency-Plus-Commodity Basket: A Proposal for Exchange Rates in Oil-Exporting Countries to Accommodate Trade Shocks Automatically (April 2017). HKS Working Paper No. RWP17-034. Available at SSRN: https://ssrn.com/abstract=3024910 or http://dx.doi.org/10.2139/ssrn.3024910

Jeffrey A. Frankel (Contact Author)

Harvard University - Harvard Kennedy School (HKS) ( email )

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HOME PAGE: http://www.ksg.harvard.edu/fs/jfrankel

National Bureau of Economic Research (NBER)

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