On the desirability of a regional basket currency arrangement

This paper constructs a theoretical model of international Trade in order to examine an optimal exchange rate regime for Asian emerging market economies that export goods to the United States. Japan, and neighboring countries. The optimality of the exchange rate regime is defined as minimizing the fluctuation of trade balances, in the environment where the yen-dollar exchange rate fluctuate; exogenously. Since the de fawn dollar peg regime is blamed as one of the factors that caused the Asian currency crisis, the question of rite optimal exchange rate regime is quite relevant in Asia. The novelty of this paper is to show how an emerging market economy's choice of the exchange rate regime (or weights in the basket) is dependent on the neighboring country's. The dollar weights in the currency baskets of the two countries are determined as a Nash equilibrium. We show that they may be stuck at the dollar peg system in both,table and unstable equilibrium cases. Even in a stable equilibrium case, there are multiple equilibria and a coordination failure may occur. (C) 2002 Elsevier Science (USA).