Modeling the impact of exchange rates using a multicurrency framework

Multiple currencies are the reality in a global economy but this reality is difficult to be replicated in a model. The GTAP model avoids this issue by converting values for each country into US dollars. This approach simplifies the model greatly; however, it ignores the important role of exchange rates in international trade and in world economic development. By adopting a multicurrency framework and adding bilateral exchange rates for any two regions, this paper provides a revised version of GTAP model, which can model the impact of exchange rate policy with ease. The impact of an appreciation of the Chinese Yuan is simulated in the paper to illustrate the way to model exchange rates. The simulation results are consistent with macroeconomic and trade theories and are well-explained by the economic structure of China and its trading partners.