Should small open economies in East Asia put all their eggs in one basket: the role of balance sheet effects

Slavi Slavov ()

International Finance from EconWPA

Abstract: 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.

Keywords: East Asia; optimal basket pegs; balance sheet effects; exchange rate regimes (search for similar items in EconPapers)
JEL-codes: F4 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ifn
Date: 2005-01-12
Note: Type of Document - pdf; pages: 35

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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpif:0501001

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