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The optimal weighting of indicators for a crawling peg

1982; Elsevier BV; Volume: 1; Linguagem: Inglês

10.1016/0261-5606(82)90012-2

1873-0639

William H. Branson, Jorge Braga de Macedo,

Economic Policies and Impacts

This paper derives optimal weights for current-account and reserve indicators for adjusting the exchange rate (a ‘crawling peg’). Kenen (1975) showed that use of a current account indicator alone would not stabilize reserves, while a reserve indicator results in unstable fluctuations in the exchange rate. This paper builds on the framework of Phillips (1954) to analyze the problem in terms of optimal control. We show that in all cases the optimal combination is a weighted average. With a fairly low variance of the current account and a large effect of an exchange rate change on the current account, the weight of the current account is quite close to its welfare weight. An increase in either the variance or the elasticities reduces the weight of the current account in the optimal formula.