A Simple Trade Model with an Optimal Exchange Rate Motivated by Discussion of a Renminbi Float

Hui Huang, Yiming Wang, John Whalley, Shunming Zhang

China Financial Policy Research Center, School of Finance, Renmin University of China, Beijing, China.
Department of Economics, Social Science Centre, The University of Western Ontario, London, Canada.
Department of Finance, School of Economics, Peking University, Beijing, China.
Faculty of Business Administration, The University of Regina, Regina, Canada.

DOI: 10.4236/me.2012.35069                

Abstract

We present a model of combined inter-spatial and inter-temporal trade between countries in which there is a fixed ex-change rate with a surrender requirement for foreign exchange generated by exports. The model incorporates inter- temporal intermediation services, which may or may not be liberlized across countries. We use numerical simulation methods to explore the properties of the model, since it has no closed form solution. In this model, when services re-main unliberalized there is an optimal trade intervention, even in the small open price taking economy case. Given monetary policy and an endogenously determined premium value on foreign exchange, an optimal setting of the ex-change rate can provide the optimal trade intervention. We suggest this model may have loose relevance for the current situation in China where services remain unliberalized and tariff rates are bound in the WTO and a free Renminbi float is under discussion.

Keywords

Fixed Exchange Rate; Foreign Exchange Premium; Services; JEL Classification: F00; F02; F31; F32

Conflicts of Interest

The authors declare no conflicts of interest.

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