Unemployment and optimal exchange rate in an open economy

China has been criticized for adopting a low yuan policy to take unfair advantage of its trading partners. This paper considers the optimal exchange rate policy of a Keynesian open economy with unemployed resources. In the case of Cobb-Douglas utility and production functions, indirect utility is monotone-increasing and concave in the exchange rate. Yuan devaluation is shown to reduce unemployment. Moreover, the optimal exchange rate is one which guarantees full employment. The United States may want to choose a different rate which ensures full employment. The two countries could negotiate an intermediate exchange rate for which some unemployment exists in both countries.