Should small open economies peg the currency to export prices?

Nominal GDP targeting makes a lot of sense for large currency areas like the US or the euro zone and it make sense that the central bank can implement a NGDP target through open market operations or as with the use of NGDP futures. However, operationally it might be much harder to implement a NGDP target in small open economies and particularly in Emerging Markets countries where there might be much more uncertainty regarding the measurement of NGDP and it will be hard to introduce NGDP futures in relatively underdeveloped and illiquid financial markets in Emerging Markets countries.

I have earlier (see here and here) suggested that a NGDP could be implemented through managing the FX rate – for example through a managed float against a basket of currencies – similar to the praxis of the Singaporean monetary authorities. However, for some time I have been intrigued by a proposal made by Jeffrey Frankel. What Frankel has suggested in a number of papers over the last decade is basically that small open economies and Emerging Markets – especially commodity exporters – could peg their currency to the price of the country’s main export commodity. Hence, for example Russia should peg the ruble to the price of oil – so a X% increase in oil prices would automatically lead to a X% appreciation of the ruble against the US dollar.

Frankel has termed this proposal PEP – Peg the Export Price. Any proponent of NGDP level target should realise that PEP has some attractive qualities.

I would especially from a Market Monetarist highlight two positive features that PEP has in common in (futures based) NGDP targeting. First, PEP would ensure a strict nominal anchor in the form of a FX peg. This would in reality remove any discretion in monetary policy – surely an attractive feature. Second, contrary to for example inflation targeting or price level targeting PEP does not react to supply shocks.

Lets have a closer look at the second feature – PEP and supply shocks. A key feature of NGDP targeting (and what George Selgin as termed the productivity norm) is that it does not distort relative market prices – hence, an negative supply shock will lead to higher prices (and temporary higher inflation) and similarly positive supply shocks will lead to lower prices (and benign deflation). As David Eagle teaches us – this ensures Pareto optimality and is not distorting relative prices. Contrary to this a negative supply shock will lead to a tightening of monetary policy under a inflation targeting regime. Under PEP the monetary authorities will not react to supply shock.

Hence, if the currency is peg to export prices and the economy is hit by an increase in import prices (for example higher oil prices – a negative supply shock for oil importers) then the outcome will be that prices (and inflation) will increase. However, this is not monetary inflation. Hence, what I inspired by David Eagle has termed Quasi-Real Prices (QRPI) have not increased and hence monetary policy under PEP is not distorting relative prices. Any Market Monetarist would tell you that that is a very positive feature of a monetary policy rule.

Therefore as I see it in terms of supply shocks PEP is basically a variation of NGDP targeting implemented through an exchange rate policy. The advantage of PEP over a NGDP target is that it operationally is much less complicated to implement. Take for example Russia – anybody who have done research on the Russian economy (I have done a lot…) would know that Russian economic data is notoriously unreliable. As a consequence, it would probably make much more sense for the Russian central bank simply to peg the ruble to oil prices rather than trying to implement a NGDP target (at the moment the Russian central bank is managing the ruble a basket of euros and dollars).

PEP seems especially to make sense for Emerging Markets commodity exporters like Russia or Latin American countries like Brazil or Chile. Obviously PEP would also make a lot for sense for African commodity exporters like Zambia. Zambia’s main export is copper and it would therefore make sense to peg the Zambian kwacha against the price of copper.

Jeffrey Frankel has written numerous papers on PEP and variations of PEP. Interestingly enough Frankel was also an early proponent of NGDP targeting. Unfortunately, however, he does not discussion the similarities and differences between NGDP targeting and PEP in any of his papers. However, as far as I read his research it seems like PEP would lead to stabilisation of NGDP – at least much more so than a normal fixed exchange regime or inflation targeting.

One aspect I would especially find interesting is a discussion of shocks to money demand (velocity shocks) under PEP. Unfortunately Frankel does not discuss this issue in any of his papers. This is not entirely surprising as his focus is on commodity exporters. However, the Great Recession experience shows that any monetary policy rule that is not able in someway to react to velocity shocks are likely to be problematic in one way or another.

I hope to return to PEP and hope especially to return to the impact of velocity-shocks under PEP.


Links to Frankel’s papers on PEP etc. can be found on Frankel’s website. See here.

Leave a comment


  1. Bill Woolsey

     /  April 15, 2012

    It is better than import prices.

    Still, prices times output of exports would be better.

    And better yet, is to add in the prices times the quantity of nontraded goods.

    If you imagine an economy so small that just about everything is imported, (like your family,) then export prices is the same thing as the prices of output.

  2. Bill, I agree that NGDP targeting in principle is better. That is obvious. However, the neat feature of Frankel’s suggestion is that you will not need much data for the central bank to follow this rule.

    Take for example – 75-80% of Russia’s export is oil and gas. So the correlation between Russian export prices and the price of oil measured in ruble is extremely high. Therefore the Russian central bank could just peg the rub directly to the oil price. This is imperfect, but there is no perfect solution in central banking – especially not for Emerging Markets with illiquidity markets and bad data quality. I certainly would not like to conduct monetary policy in Russia based on the official data for Russian NGDP. Furthermore, NGDP data is available with an extremely long lag in Russia which just makes the task even harder.

    Therefore, PEP might be the best solution for commodity exporting Emerging Markets.

  3. am

     /  January 29, 2014

    Can I have permission to post this to

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