Should Indonesia adopt a basket currency regime?

Ahmad Prasetyo, Camelia Magdalena, Brian Charvia and Mandra Lazuardi Kitri

Afro-Asian Journal of Finance and Accounting, 2020, vol. 10, issue 4, 494-513

Abstract: Exchange rate regime is a system in which a country manages its currency about other currencies and the foreign exchange market. Currently, there are two major types of exchange rate regimes, i.e., free-float system and pegged system. Many countries, including Indonesia, adopted the free-float system since it is believed as the best regime for absorbing external economic shocks. However, some economists argued that a moderate exchange rate regime, such as currency basket system, is a better approach for achieving the government's goals. The research aims to provide an arrangement for optimal basket weights of Indonesian currency basket to minimise GDP volatility as well as exchange rate volatility. We develop an optimisation model in the extension of Yoshino et al. (2017) by adding five currencies in the basket. We found that the weight currencies in the free-float regime would reflect the trade intensities of the respective countries. Further, the government should monitor the change of exchange rates of currencies in the foreign reserves and change the weight accordingly. In addition, we also found that, whether the government implementing basket currency regime or free-float regime, it will make no significant differential effect on GDP gap volatility.

Keywords: exchange rate regime; basket currency; foreign reserve; GDP gap; exchange rate gap; Indonesia. (search for similar items in EconPapers)
Date: 2020
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