The optimal currency basket under vertical trade

Juanyi Xu ()

Journal of International Money and Finance, 2011, vol. 30, issue 7, 1323-1340

Abstract: This paper explores the theory of optimal currency basket in a small open economy general equilibrium model with sticky prices. In contrast to existing literature, we focus on an economy with vertical trade, where the currencies in the basket may play different roles in invoicing trade flow. In a simple two-currency basket, one currency is used to invoice imported intermediate goods and is called “import currency”, while the other currency is used to invoice exported finished goods and is called “export currency”. We find that the optimal weights of the import currency and the export currency depends critically on the structure of vertical trade. Moreover, if a country decides to choose a single-currency peg, the choice of pegging currency also depends on how other competing economies respond to external exchange rate fluctuations.

Keywords: Vertical trade; Import currency; Export currency; Currency basket peg; Welfare (search for similar items in EconPapers)
JEL-codes: F3 F4 (search for similar items in EconPapers)
Date: 2011
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jimfin:v:30:y:2011:i:7:p:1323-1340

DOI: 10.1016/j.jimonfin.2011.07.002

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