Basket Peg Research Articles

Assessment of Fiji’s exchange rate

This paper empirically estimates Fiji’s bilateral equilibrium real exchange rate with two of its key trading partners, the US and Australia. Applying the Behavioural Equilibrium Exchange Rate (BEER) approach, we estimate the equilibrium exchange rate by considering the productivity differential, real interest rate differential, net foreign assets, money supply, and terms of trade. Using monthly data from March 2011 to September 2022 and a system approach to cointegration, a strong relationship between the real exchange rate and its fundamentals is found, but importance of factors differed by trading partner. Our findings show that the Fijian Dollar has been undervalued against both US Dollar and Australian Dollar in recent years, but to varying degrees. Our analysis underlines the importance of assessing bilateral exchange rate misalignments in basket pegs when devising exchange rate policy.

Monetary Policy Spillovers under Intermediate Exchange Rate Regimes

Testing the international Trilemma traditionally relies on discretely classified exchange rate regimes. This simplification limits the implications drawn for middle-ground policies like managed floats or basket pegs, and inhibits inference on the empirical shape of the exchange rate stability -- monetary autonomy trade-off. To address these issues, this paper proposes a continuous measure of exchange rate flexibility for estimating monetary policy spillovers along the entire spectrum of peg intensities. Monetary spillovers generally increases with exchange rate stability, even within middle ground policies, and basket pegs diversify such spillovers. Using machine learning techniques, I then test for non-linearities, and show that the relationship between monetary autonomy and exchange rate stability is significantly non-linear: partially targeting the exchange rate translates to disproportionately smaller or larger monetary spillovers along middle-ground exchange rate regimes. For emerging markets in particular, active reserves management is a key mechanism associated with relaxing the Trilemma.

Monetary policy spillovers under intermediate exchange rate regimes

Testing the international Trilemma traditionally relies on discretely classified exchange rate regimes. This simplification limits the implications drawn for middle-ground policies like managed floats or basket pegs, and inhibits inference on the empirical shape of the exchange rate stability – monetary autonomy trade-off. To address these issues, this paper proposes a continuous measure of exchange rate flexibility for estimating monetary policy spillovers along the entire spectrum of peg intensities. Monetary spillovers generally increase with exchange rate stability, even within middle ground policies, and basket pegs diversify such spillovers. I then estimate the empirical shape of the trade-off using machine learning techniques, finding that the relationship between monetary autonomy and exchange rate stability is significantly non-linear in both advanced economies and emerging markets. Specifically, partially targeting the exchange rate translates to disproportionately smaller or larger monetary spillovers along middle-ground exchange rate regimes. For emerging markets in particular, active reserves management is a key mechanism associated with these non-linearities.

Sustainability of basket peg choices in the post-COVID-19 era: new evidence from Morocco & Tunisia

ABSTRACT This article aims to study the impact of peg structure on volatility behaviour and crisis vulnerability, considering the COVID-19 economic context. We adopt a comparative analysis of volatility behaviour using GARCH family models and the ICSS Algorithm for the cases of Morocco and Tunisia. Our main finding is that peg characteristics aren’t the unique parameters impacting volatility behaviour and the exposition to the crisis. Furthermore, we detect different variations in volatility parameters as a result of the contrasting economic contexts and COVID-19 economic fallouts. Finally, we present some interesting policy implications, and we suggest some leads for future research.

Has the efficiency of foreign exchange markets in India evolved over time?

PurposeThe purpose of this paper is to determine whether foreign exchange markets in India have become more efficient over time. There were two major developments in India’s foreign exchange market since the 1980s: first, a shift in foreign exchange management regime from a basket peg to a free float; and second, a rapid phase of economic liberalization since the mid-1990s. The paper attempts to find out whether the market efficiency of foreign exchange markets is affected by these developments. The paper mainly uses the well-known Hurst exponent calculated through corrected empirical R over S analysis to determine whether the exchange rates possess long memory. The robustness of the method is tested by calculating the Hurst exponent through two other prevalent methods in the literature.Design/methodology/approachThe authors apply the corrected empirical Hurst exponent which employs the Anis Lloyd correction with the modification suggested by Weron. The sensitivity of the results is then tested by replicating the calculations using the detrended fluctuation analysis and Robinson’s method.FindingsAll the methods show that: first, there is no significant change in the overall efficiency of the foreign exchange market vis a vis the US$ for the time period from 1980 to 2017. Second, neither regime shifts nor calculations over sub-time periods is able to identify significant change in the efficiency level of the market for the US$ exchange rate. Third, efficiency of different exchange rate markets are different over the time period 1999–2017. The US$ market has unequivocally more long run memory compared to the GBP, Yen and EURO markets. Fourth, the results are robust to the method used for calculations.Originality/valueDoes the efficiency of asset markets evolve over time? This paper attempts to answer this question. In the process, the paper studies the effect of regime shifts and progressive globalization on the ability of the market to internalize information.

為替制度の移行における動学的な最適経路： 中国，シンガポール，マレーシアの分析

We consider the optimal exchange rate regime transition policy for three East Asian countries: the People’s Republic of China (PRC), Malaysia, and Singapore. In contrast to two traditional approaches to exchange rate regimes in East Asia, we conduct a dynamic transition analysis. Based on a small, open-economy dynamic stochastic general equilibrium model applied to these three countries, we define transition policies from a dollar peg regime to either a basket peg or a floating regime and compare the welfare gains of these policies relative to maintaining the current dollar peg regime. The quantitative analysis using PRC, Malaysian, and Singaporean data shows that the PRC would be better off shifting gradually from a dollar peg to a basket peg. In response to the PRC’s shift, both Malaysia and Singapore would opt to shift gradually to a basket peg regime.

Exchange rate regime switching in Malaysia and Singapore in response to China’s move to a basket peg: A DSGE analysis

Motivated by the observation that when China broke from its US dollar peg in 2005, Malaysia and Singapore likewise loosened their currency ties to the US dollar, this paper considers how these two countries might best respond to a hypothetical transition by China to a new basket peg regime. We specify five alternative exchange rate strategies that encompass fixed, basket, and floating regimes and gradual versus sudden transitions. To project outcomes for macroeconomic variables under these alternative regimes, we apply a dynamic stochastic general equilibrium (DSGE) model of a small open economy and incorporate exogenous shocks as actually occurred from 2005 Q1 to 2014 Q4. We then compare the strategies based on values of a cumulative loss function defined on the output gap, the inflation rate, and the real effective exchange rate. The exercise reveals that a gradual adjustment to a basket peg with long-term optimal weights is the first-best policy for both countries, where optimal weights are derived to minimize the loss function. Further, both a sudden shift to a basket peg with optimal weights and a sudden shift to a floating rate regime are superior to maintaining the dollar peg in Malaysia, but not to maintaining the existing basket peg in Singapore.

The mystery of the Chinese exchange rate regime: basket or no basket?

ABSTRACTEconomists have taken for granted the claim made by the Chinese government that the policy shift introduced in July 2005 constituted a change in the exchange rate regime from a fixed peg to a basket peg. We demonstrate that neither the stylized facts nor the empirical evidence support the proposition of a basket peg and suggest several reasons as to why China has not adopted this regime. The results could prove useful for identifying the Chinese exchange rate regime in the aftermath of the perceived policy shift following the August 2015 devaluation.

Dynamic Effects of Changes in the Exchange Rate System

We propose a new dynamic transition analysis on the basis of a small open economy dynamic stochastic general equilibrium model. Our proposed analysis differs from existing static and conventional dynamic analyses in that shifts from a fixed exchange rate regime to a basket peg or a floating regime are explicitly explored. We apply quantitative analysis, using data from the People's Republic of China and Thailand, and find that both economies would be better off shifting from a dollar peg to a basket peg or a floating regime over the long run. Furthermore, the longer the transition period, the greater the benefits of shifting to a basket peg regime from a dollar peg regime owing to limited volatility in interest rates. Regarding sudden shifts to a desired regime, the welfare gains are larger under a shift to a basket peg if the exchange rate fluctuates significantly.

Identification of a basket peg: the model specification controversy

ABSTRACTA controversy has been triggered by the Chinese exchange rate regime shift from a single currency peg to an alleged basket peg. The controversy is about the specification of the model used to represent the basket as three models have been used: levels, log levels and first log differences. It is suggested that one way to confirm the validity or otherwise of a model is to use data on the special drawing rights exchange rate since the currency weights are known. The results show that the estimated weights are almost identical no matter which model and which numeraire is used. However, nonnested model selection criteria show that the best model is that written in levels, simply because this is what is used in practice by central banks adopting basket pegs.

Dynamic Analysis of the Exchange Rate Regime: Policy Implications for Emerging Countries in East Asia

AbstractThis paper discusses exchange rate policies in East Asia. In particular, we explore whether actual policies that have been implemented by East Asian countries after the Asian Financial Crisis follow or deviate from theoretically “desirable” policies over the medium and long terms. On theoretical analysis, we show the relative superiority of a basket‐peg regime with the basket weight rule when compared with a floating regime implementing the interest rate rule or money supply rule. For countries that currently adopt a fixed exchange rate regime, they would be better off shifting toward either a basket‐peg or a floating regime over the medium term. A shift to a basket peg is more preferred when compared with a shift to a floating regime when the exchange rate fluctuations are large.

Dynamic Shift to a Basket-Peg or Floating Regime in East Asian Countries in Response to the People's Republic of China's Transition to a New Exchange Rate Regime

This paper analyzes a desirable transition path for East Asian countries given the People's Republic of China's (PRC's) transition to a new exchange rate regime. It attempts to answer two main questions: (i) Would these countries be better off shifting to either a basket peg or a floating regime following the PRC's transition to a basket peg regime? (ii) How and when should these countries shift to the desired regime? The paper captures the influence of the PRC's predetermined shift in its exchange rate regime on East Asian countries' decisions regarding their optimal transition policies based on a dynamic stochastic general equilibrium (DSGE) model of a small open economy. Our calibration exercise using Malaysian and Singapore data from the first quarter (Q1) of 2000 to Q4 2012 reveals that a gradual adjustment to a basket peg is the most desirable policy for both countries. A sudden shift to a basket peg is superior to maintaining a dollar peg in Malaysia, but not in Singapore. Finally, a sudden shift to a floating regime is even worse than maintaining a dollar peg in both countries.

Dynamic Effect of a Change in the Exchange Rate System: From a Fixed Regime to a Basket-Peg or a Floating Regime

This paper theoretically evaluates the dynamic effects of a shift in an exchange rate system from a fixed regime to a basket peg, or to a floating regime, and obtains transition paths for the shift based on a dynamic stochastic general equilibrium model of a small open economy. We apply quantitative analysis using data from the People's Republic of China and Thailand and find that a small open country would be better off shifting to a basket peg or to a floating regime than maintaining a dollar-peg regime with capital controls over the long run. Furthermore, due to the welfare losses associated with volatility in nominal interest rates, the longer the transition period, the larger the benefits of shifting suddenly to a basket-peg regime from a dollar-peg regime than proceeding gradually. Regarding sudden shifts to desired regimes, the welfare gains are higher under a shift to a basket peg if the exchange rate fluctuates significantly. Finally, shifting to a managed-floating regime is less attractive than moving to a basket peg, as the interventions necessary to maintain the exchange rate for certain periods result in higher losses and the authority lacks monetary policy autonomy.

Dynamic Transition of the Exchange Rate Regime in the People's Republic of China

This paper analyzes the optimal transition of the exchange rate regime in the People’s Republic of China (PRC). How the PRC can successfully reach the desired regime — whether a basket peg or floating regime — from the current dollar-peg regime remains a major question. To answer it, we develop a dynamic small open-economy general equilibrium model. We construct four transition policies toward the basket-peg or floating regime and compare the welfare gains of these policies to those of maintaining the dollar-peg regime. Quantitative analysis using PRC data from Q1 1999 to Q4 2010 leads to two conclusions. First, a gradual adjustment toward a basket-peg regime seems the most appropriate option for the PRC, and would minimize the welfare losses associated with a shift in the exchange rate regime. Second, a sudden shift to a basket peg is the second-best solution. This is preferable to a sudden shift to a floating regime, since it would enable the authorities to implement optimal weights efficiently in order to achieve policy goals once a decision has been made to adopt a basket-peg regime.

Dynamic Transition of Exchange Rate Regime in China

AbstractThe paper considers the optimal transition path for China's exchange rate regime. How can China successfully make the shift from the current dollar peg regime to a more desirable regime, whether a basket peg or a floating regime? To answer this question, we develop a dynamic small open economy general equilibrium model. We construct four transition policies based on a basket peg or a floating regime and compare the welfare gains of these policies relative to maintaining the dollar peg regime. Two main results are derived from the quantitative analysis using Chinese data from 1999Q1 to 2010Q4. First, following a gradual adjustment to a basket peg regime is the most appropriate path for China to take, with minimal welfare losses associated with the shift in the exchange rate regime. Second, a sudden shift to the basket peg is the second best solution, and is superior to a sudden shift to floating because the monetary authority can efficiently determine optimal weights to attach to currencies in the basket to achieve policy goals once they adopt a basket peg regime.

Optimal exchange rate policy for a small oil-exporting country: A dynamic general equilibrium perspective

This paper examines the choice of optimal exchange rate regime for an oil-exporting small open economy using a welfare-based model. The paper extends the standard New Keynesian Small Open Economy model to include three countries: a small oil-exporting country and two large foreign countries. The model also features three sectors: traded, non-traded, and primary-commodity (crude-oil). The sources of uncertainty are random monetary (demand), productivity (real), and real oil price (supply) shocks. Despite the absence of a non-oil traded sector in this primary-commodity economy, the welfare analysis suggests that flexible exchange rate regimes can reduce external shocks and consumption volatility given certain caveats about pricing-schemes. The analysis also suggests that a basket peg is more welfare-improving than a unilateral peg, as higher volatility of the anchor currency reduces consumer welfare.

Choice of Anchor Currencies and Dynamic Preferences for Exchange Rate Pegging in Asia

This paper attempts to answer two important questions in the context of Asian exchange rate regimes with respect to the choice of anchor currencies and dynamic preferences for exchange rate pegging. According to our results, the US dollar is the first choice of a de facto peg for many countries such as China, Hong Kong, the Philippines, and Pakistan. Other countries, apart from Korea and Indonesia, seem to prefer a basket peg comprising two or more anchor currencies with rapidly increasing weight attached to the euro. This shift from the US dollar to the euro reflects changes in the choices, preferences, and policies of these economies as a result of varying macroeconomic and global financial realities.

Re‐pegging the renminbi to a basket: issues and implications

On 19 June 2010, the Chinese authorities announced that the renminbi (RMB) was henceforth to be managed with reference to a currency basket. Yet, it has subsequently quite closely followed the USD, although having appreciated gradually by 7.7 per cent up to the time of writing. The details of the composition of the basket have not been announced. Despite having appreciated against the USD, the RMB became first significantly weaker against a broad trade‐weighted basket, and the EUR and the JPY, and this situation held until September 2011. China has announced at international forums that the RMB exchange rate regime will be reformed further. We discuss here what a transparent basket peg could mean for China. To reduce the overall volatility of the RMB exchange rate, the weight for the EUR should be significantly increased, with the special drawing right basket being one option for practical implementation. This would also have a positive impact on the EU. China's currency reform has possible implications for its USD‐dominated asset holdings. Reducing them could trigger a further depreciation of the USD. The potentially costly consequences call for new rules for the global financial architecture. However, China's economic expansion will inevitably lead to a diminishing international role for the USD.

Still on China's exchange regime: the Euro and its role as an international anchor currency

This study will demonstrate, through an econometric model in time series, if and how the Chinese basket peg has changed in relation to the weight that the European single currency holds within it. Specifically, utilizing Frankel’s (1994) econometric model, as revisited by Mele (2010) enriched by Kalman’s filter, our objective is to verify if the Eurozone crisis has affected the inner balance of the Chinese basket-peg, swaying it from the Euro towards a more favorable dollar. This research could be of great insight in predicting the effect of future crisis’, as a shift is already noticeable in our time series study spanning from 2010 till present day.

Exchange Rate Volatility Under Peg: Do Trade Patterns Matter?

This paper assesses the role of trade patterns in shaping the volatility of the effective exchange rate under two alternative peg regimes: a hard peg to a single currency and a peg to a basket of currencies. I link the changes in the nominal effective exchange rate of a pegged currency to the fluctuations of its anchor vis-a-vis other major currencies, with an emphasis on the dynamics of trade patterns. In an application to the WAEMU (West African Economic and Monetary Union), I find that the nominal effective exchange rate of the union was twice as volatile under the hard peg to the euro as it would have been under a hypothetical basket peg over the past decade. This result was driven by the substantial shifts that occurred in WAEMU trade patterns, away from euro area countries and toward the BICs (Brazil, India, and China). These findings suggest that policymakers should pay as much attention to the type of peg as to pegging in itself, with a particular focus on the dynamics of trade patterns.