Choice of currency basket weights and its implications on trade balance

Abstract

This paper seeks to find an optimal choice of currency basket weights for emerging economies that peg their currencies to a currency basket, and to examine the long-run relationship between the real exchange rates of a group of trading partners. A general equilibrium model is set up to establish an optimal set of currency basket weights, coupled with the choice of fiscal policy, to simultaneously stabilize trade balance and aggregate price level of an economy. This optimal set of weights is a weighted average of two sets of weights; each targets at one policy goal (stabilizing either balance of trade or aggregate price level) at a time. Empirical studies including vector autoregression (VAR) analysis and cointegration analysis on the long-run relationship between the Thai baht and the real exchange rates of its major trading partners are presented.