Abstract
We present a model of combined inter-spatial and inter-temporal trade between countries in which there is a fixed ex-change rate with a surrender requirement for foreign exchange generated by exports. The model incorporates inter- temporal intermediation services, which may or may not be liberlized across countries. We use numerical simulation methods to explore the properties of the model, since it has no closed form solution. In this model, when services re-main unliberalized there is an optimal trade intervention, even in the small open price taking economy case. Given monetary policy and an endogenously determined premium value on foreign exchange, an optimal setting of the ex-change rate can provide the optimal trade intervention. We suggest this model may have loose relevance for the current situation in China where services remain unliberalized and tariff rates are bound in the WTO and a free Renminbi float is under discussion.
Highlights
This paper takes as its point of departure macro literature on the choice of exchange rate regime
We present a model of combined inter-spatial and inter-temporal trade between countries in which there is a fixed exchange rate with a surrender requirement for foreign exchange generated by exports
Given monetary policy and an endogenously determined premium value on foreign exchange, an optimal setting of the exchange rate can provide the optimal trade intervention. We suggest this model may have loose relevance for the current situation in China where services remain unliberalized and tariff rates are bound in the WTO and a free Renminbi float is under discussion
Summary
This paper takes as its point of departure macro literature on the choice of exchange rate regime. We only consider the transaction demand for money and in our formulation all foreign exchange earnings of exporters are surrendered to the central bank at the fixed exchange rate, while foreign exchange received by the bank is auctioned among importers at a premium to the official exchange rate This premium value is endogenously determined given monetary policy, and operates akin to a tariff. If costlessly provided foreign supplied intermediation services are allowed in the model, we can characterize a free trade in services equilibrium as a case where across period budget constraints hold rather than period by period budget constraints In this model form, we assume the interest rate r is endogenously determined on the country capital market to clear demand for and supply of loans. The possibility of such outcomes in the model can be explored by numerical simulation in which fixed exchange rates are parametrically varied
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