Exchange Rate Indicators and Optimal Currency Baskets : A Macroeconomic Analysis with Application to Developing Countries

This paper presents a framework for deriving and estimating an optimally-weighted exchange rate index within a general equilibrium model. The weighting method is shown to be equivalent to the optimal control approach of Turnovsky (1982), suggesting that the optimally-weighted exchange rate index might also be useful for the purposes of stabilization policy. Optimally-weighted exchange rate indices are constructed for a group of Asian developing countries using a vector autoregression model. The properties of the weighted indices are examined and their usefulness for policy, both as economic indicators and as currency baskets is discussed