Identification of a basket peg: the model specification controversy

ABSTRACT

A controversy has been triggered by the Chinese exchange rate regime shift from a single currency peg to an alleged basket peg. The controversy is about the specification of the model used to represent the basket as three models have been used: levels, log levels and first log differences. It is suggested that one way to confirm the validity or otherwise of a model is to use data on the special drawing rights exchange rate since the currency weights are known. The results show that the estimated weights are almost identical no matter which model and which numeraire is used. However, nonnested model selection criteria show that the best model is that written in levels, simply because this is what is used in practice by central banks adopting basket pegs.

KEYWORDS:

• Exchange rate regime verification
• basket peg
• SDR

JEL CLASSIFICATION:

• F31
• F33

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ For details, see International Monetary Fund (2005), particularly Box 3 on page 8 and Appendix II, pp 30-31.

² It is not necessary or customary to calculate the weights as elasticities at the mean values. To calculate the exchange rate of the SDR, the IMF uses exchange rates at the base period and the ‘transition date’. The weights and currency amounts are kept constant over a long period of time to ensure that the exchange rate of the SDR against the US dollar changes only in response to changes in the bilateral exchange rates of the component currencies against the dollar.

³ http://www.imf.org/external/np/fin/data/rms_sdrv.aspx

⁴ For details, see Pesaran and Pesaran (2009).