The basket-peg, dollar-peg, and floating: A comparative analysis

The topic of this paper is the optimal exchange rate regime for a small open economy. We argue that the best exchange rate regime depends on the policy goal. Small open economies, such as those that experienced the recent currency and economic crises in Asia, should decide for themselves what their policy goals are, and then choose the exchange rate regime that is most conducive to achieving those goals. Adopting a basket-peg with trade weights will not in general be the optimal choice. In comparison to the dollar-peg, there are three possible advantages to the peg against the basket comprising two currencies, say the dollar and the yen. If the policy goal is to maintain monetary policy autonomy, then the best exchange rate regime is floating exchange rates, provided the autonomy is used wisely.