Final Draft
Exchange Rate Arrangement in East Asia*
Eiji Ogawa
Professor
Hitotsubashi University, Tokyo, Japan
and
Doo Yong Yang
Research Fellow
Korea Institute for International Economic Policy
Summary
This paper analyzes the exchange rate flexibility in East Asia, and explores what has changed since
the Asian crisis. Our focus is given not on the choice of appropriate exchange rate regime in East
Asia, but rather on exchange rate flexibility and management in the region. We find that the
exchange rate management in East Asia differs depending on the countries and the time period. We
identify what are major concerns on the current exchange rate arrangement in East Asia, including
asymmetric responses to external shocks, competitive devaluation, and dilemma between asset
dollarization and liability dollarization. It concludes some policy implications on exchange rate
arrangement in East Asia.
* This paper is prepared for the project on Exchange Rate and Monetary Arrangement in East Asia,
organized by KIEP, Seoul, Korea on August 26-27, 2004. We are indebted to Kim Kwon Sik for the excellent
assistant provided in our research for statistics and other data collections.
I. Introduction
The Asian crisis has provoked the choice of exchange rate regime more seriously since 1997,
since one of the root causes of the crisis was pointed to the rigid exchange rate arrangement. Even
though searching for an appropriate exchange rate regime has had a long history in the Western
hemisphere, serious concerns on an exchange rate system in East Asia were recently raised due to
the heterogeneity of exchange rate regimes in the region. The center of the debate lies in whether
emerging market economies with a weak financial system and increasing capital mobility are able to
maintain an intermediate exchange regime for the long run. According to the bipolar view on
exchange rate arrangements, countries generally should be moving to one extreme or the other
since any intermediate regimes are nonviable due to increasing capital mobility. One extreme choice
on the spectrum of exchange rate regimes is a perfect flexible exchange rate regime, and the other
is a hard peg or credible peg, such as currency board or dollarization. Therefore, any other
exchange rate regimes between two extremes are inherently unstable and crisis-prone (Eichengreen
1994 and Fisher 2001). Recognizing this point of view, crisis-hit countries in East Asia have
adopted more flexible exchange rate regime since 1997. However, Calvo and Reinhart (2002) argue
while countries say they allow their exchange rate to float mostly, in practice they do not. There
seems to be an epidemic case of fear of floating. In general emerging market economies face
several difficulties with the two extreme regimes, and have a tendency toward intermediate regimes
due to a weak financial system, fiscal instability, currency substitution and liability dollarization, and
vulnerability to sudden stops of capital flows (Calvo and Mishkin 2003).
For emerging East Asian countries, there has been an increase in the number of countries in
East Asia that have adopted more flexible exchange rate regime since the Asian crisis. However,
there have also been differences in the way they managed exchange rates among floaters. It seems
that East Asian countries move in the direction of a relatively inflexible exchange rate and freer
2
capital movements. In a spectrum of exchange rate arrangement, the choice of exchange rate
regimes in East Asia is limited
This paper analyzes that the exchange rate flexibility in East Asia, and explores what has
changed since the Asian crisis. Our focus is given not on the choice of appropriate exchange rate
regime in East Asia, but rather on exchange rate flexibility and management in the region. We will
identify what are major concerns on the current exchange rate arrangement in East Asia.
II. Exchange Rate Flexibilities in East Asia
Before the Asian crisis, most currencies in East Asia are generally pegged to the US dollar with
different degree of fixity. However, the Asian crisis produced more diversified exchange rate
regimes in East Asia. After the Asian crisis in 1997, crisis countries chose freer floating exchange
regime and implemented capital and foreign exchange market liberalization. However, some argued
that when the crisis subdued, some countries moved toward a rigid pegged system due to
difficulties in maintaining a floating exchange rate regime, known as the fear of floating.
Nevertheless, the current exchange rate regimes in East Asia are different from the pre-crisis era.
Various exchange arrangements co-exist in the region from hard peg (currency board) in HongKong, fixed regime in China and Malaysia, and relative flexible regimes in Korea, Thailand, and
Indonesia, to mostly free-floating in Japan. This section will analyze what are the stylized facts on
exchange rates related issues in East Asia, especially before and after the Asian crisis. Selected
countries include ASEAN5 (Indonesia, Malaysia, Singapore, Thailand and the Philippines), Hong
Kong, Taiwan, China, Japan and Korea. The period of analysis is set from January 1990 to April
2004. Data was taken from IMF International Financial Statistics.
3
Nominal and Real Exchange Rate Behaviors
This section presents the nominal and real exchange rate behaviors in East Asian countries
before and after the Asian crisis. It is reasonably believed that the exchange rate behaviors in East
Asia has been changed since the crisis because crisis-hit countries opened their economy more, and
these countries adopted more flexible exchange rate regime. To analyze these regime changes,
statistical analysis is conducted by dividing a sample period into two sub-periods before and after
the Asian Crisis. The pre-crisis period starts from January 1990 to December 1996 and the postcrisis period is from January 1999 to April 2004. Since foreign exchange markets in East Asia were
unstable in 1997 and 1998, both of the years 1997 and 1998 are excluded as it might influence
statistical analysis. Data statistics for real and nominal exchange rates reported in Table 1, 2, 3 and
41. Major stylized facts are as follows.
First, most of the nominal exchange rates under relatively flexible exchange rate regimes
showed more volatile behaviors in the pre-crisis period than in the post-crisis period. According to
Table 1 and 2, standard deviation of nominal exchange rates among the free float group (Indonesia,
the Philippines, Korea, Singapore, Thailand, and Taiwan) increased after the crisis in general. While
the standard deviation of Thailand baht/US dollar exchange rate was 0.012 in the pre-crisis period,
it was enlarged into 0.064 more than five times. The Philippine peso/US dollar also showed
increased volatility in the post-crisis period from 0.057 to 0.129. The Indonesia rupiah/US dollar
showed increased volatility from 0.078 to 0.116. The Korea won and the Taiwan dollar slightly
increased their nominal exchange rate volatilities in the post-crisis period. On the other hands,
those of the Japanese yen and the Singapore dollar reduced in the post-crisis period, from 0.154 to
0.069 and from 0.091 to 0.026, respectively. Fixed group (China, Hong Kong and Malaysia) showed
1 Real exchange is calculated as the ratio of foreign consumer price index to domestic one multiplied by
nominal exchange rates.
4
near zero volatility on nominal exchange rates in the post-crisis period with no adjustment of peg
rates.
Second, volatilities of real exchange rates of the floating group also increased in the post-crisis
period while volatilities under the pegged regimes were reduced. The Indonesia rupiah, the Thai
baht, the Taiwan dollar, and the Korean won showed higher volatilities on real exchange rates in
the post-crisis period. But the Japanese yen, the Singapore dollar, and the Philippine peso reduced
them in the post-crisis period. The fixed group also reduced their real exchange rates’ volatilities in
the post-crisis period. Comparing changes in nominal and real exchange rate volatilities in both the
periods, it is indecisive whether the exchange rate pass through to domestic price level is higher or
not. In general, the volatilities on nominal and real exchange rates are indistinguishable so it is
difficult to determine whether inflation of emerging economies in East Asia rises with exchange
rate flexibility. For example, the volatility of Korean won/US dollar exchange rates increased in the
post-crisis period both in nominal and real terms, but nominal volatility is slightly higher than real
volatility. On the contrary, the increased volatility of Thailand baht in nominal term is more than 5
times, but in real term it is only doubled.
Third, most of the East Asian currencies have a higher correlation with the Japanese yen both
in nominal and real terms in the post-crisis period. According to Table 5, 6, 7, and 8, the Korean
won, the Philippine peso, and the Taiwan dollar have increased correlation with the Japanese yen in
terms of nominal exchange rates in the post-crisis period while the ASEAN currencies have
decreased correlation with the Japanese yen. However, correlation of most the selected currencies
with the Japanese yen increased in terms of real exchange rates in the post-crisis period.
Lastly, nominal exchange rates have a tendency to converge since the Asian crisis, while real
exchange rates diverge (see Figure 1 and 2). It is interesting that nominal exchange rate moves
together with each other, but the real exchange rate moves independently. This may implies that the
5
monetary policies in East Asia are somewhat independent of exchange rate behavior under the
variety of exchange rate regimes. Moreover, divergence of the East Asian currencies might reflect
divergence of economic fundamentals under the variety of exchange rate regimes.
<Table 1>, <Table 2>, <Table 3>, <Table 4>, <Table 5>, <Table 6>, <Table 7>, and Table <8> here2
<Figure 1> and <Figure 2> here
Peg to the Dollar
The degree of pegging to the US dollar provides one of measures for the flexibilities of
currencies. It has been argued that after the Asian crisis, those countries hit by the crisis shifted
their exchange rate regime from the dollar-peg to a floating exchange rate regime. The degree of
pegging to the US dollar was reduced. However, after the crisis when the crisis subdued, some
countries moved toward a dollar-pegged regime or de facto dollar pegging due to difficulties in
maintaining a floating exchange regime, sort of a fear of floating.
Most empirical analyses on the degree of pegging to the US dollar have been used the
methodology developed by Frankel and Wei (1994)3. In this approach, the Swiss franc is considered
to be an independent numeraire when they regress a local currency on the US dollar. We conducted
a similar empirical analysis to investigate how much degree of linkages of East Asian currencies has
with the US dollar. This exercise shows that the deviation from unity for the coefficient of the US
dollar indicate the degree of flexibility of the currency against US dollar by revealing East Asia’s
fear of floating. The regression model is as follows
2
3
Most correlation values are statistically significant
See also Ogawa (2000a), Baig (2001), Kawai and Akiayama (2000), and McKinnon (2000)
6
(1) d log (S local / SFR ) = α 0 + α 1d log (S US / SFR )+ α 2 d log (S JPY / SFR )+ α 3d log (S GMR / SFR )+ ε
where S local / SFR indicates nominal exchange rate of a local currency in terms of the Swiss franc,
and three major currencies (the US dollar, the Japanese yen, and the German mark are expressed in
terms of the Swiss franc. The sample data is collected from January 1990 to April 2004.
To find the regime change in the degree of pegging to the US dollar, we estimate equation (1)
by recursive least squares estimation4. The estimation is executed repeatedly using larger subsets of
the sample data. This method enables us to trace the structural break for the coefficient of US
dollar to the Swiss franc ( α1 ) by using a maximum available sample data in the estimation. If the
estimated coefficient shows significant variation or dramatic jump, we can infer a structural break.
Table 9 reports the estimation result. It shows that coefficients on the US dollar reveal the
different degree of dollar pegging in a long horizon. For China, Hong Kong, the Philippines, and
Korea, the dollar coefficients are nearly unity ranging from 0.99 to 0.90. On the other hand,
Singapore, Thailand and Indonesia have lower dollar coefficients. Moreover to illustrate the
dynamic feature of the dollar coefficients, we plot the changes on the coefficients of US dollar
weights with two standard deviations of the coefficients that indicate the 95 % statistical significant
level (Figure 3). According to Figure 3, most of the crisis-hit countries in the region show structural
break during the Asian crisis in representing higher standard deviations on dollar coefficients since
1997. In addition, there are downward pressures on the dollar coefficients in crisis-hit countries
since the Asian crisis. This exercise tells us that there are structural changes in exchange rate
flexibilities in the floating group, and the degree to which the currencies are linked to the US dollar
4 Most previous empirical estimation estimates the weight of US dollar in terms of numeraire for a given
frequency such as quarter or year.
7
has been relatively reduced since the crisis5.
<Table 9> here
<Figure 3> here
De Jure vs De Facto Exchange Rate Classification
Related to the exchange rate regime issue in East Asia, there is a growing recognition that the
exchange rate regime a country declares often differ from it operational regime. Even though crisishit countries in East Asia including Korea, Indonesia, Thailand, as well as non- crisis countries such
as Singapore and Taiwan, officially announced a certain type of exchange rate regime, most of
them actually have substantially less flexibility of their exchange rate than announced by having
exhibited a fear of floating.
The IMF exchange rate classification has a long history of comprehensive and frequent
updating for countries’ exchange rate regime. The official IMF exchange regime classification
categorized member’s exchange rate regimes based on their official announcement to the IMF.
From 1975 to 1998, depending on their own official declaration of the degree of exchange rate
flexibility, the exchange rate regimes were classified into three basic categories which were divided
into 15 subcategories: pegs, limited flexibility (usually within a band or cooperative arrangement)
and more flexibility (managed or free floats). However, the IMF classification did not reflect the
true exchange rate regime of a specific country since exchange rate regimes often differed from
5
We did not report the coefficient of Janpanese Yen to the Swiss franc ( α 2 ). However, Singapore has
significant non-zero α 2 thoroughout the period, and several countries have significant non-zero α 2 after
the Asian crisis including Korea, Taiwan, and Thailand.
8
what the authorities were officially declared to be.
Recognizing this problem, the IMF moved to a more de facto classification in January 1999. The
new classification combines available information on the exchange rate and monetary policy and
authorities’ formal or informal policy intentions with data on actual exchange rate and reserves
movement to reach a judgment on the actual exchange rate regime (IMF 1999). The new system
classified exchange rate regimes into eight categories: regime with no separate legal tender, currency
boards, conventional fixed (peg against a single currency or a basket of currencies), pegged
exchange rates within horizontal bands, crawling pegs, crawling bands, managed floating with no
predetermined path for exchange rate and finally independently floating.
Levy-Yeyati and Sturzenegger (1999) raised a question on the IMF old de jure classification.
They constructed a de facto classification based on data on exchange rates and international reserves
from all IMF-reporting countries over the period of 1974-2000, which they believed provides a
meaningful alternative for empirical analysis on exchange rate regimes. They used three variables
related to exchange rate behavior: exchange rate volatility, volatility of exchange rate changes, and
volatility of reserves. In theory, flexible exchange rates are characterized by no or little intervention
in the exchange rate markets with unlimited volatility of the nominal exchange rate. Conversely, a
fixed exchange rate regime displays no or little volatility in the nominal exchange rate while reserves
fluctuate substantially. On the other hand, an intermediate exchange regime corresponds to the case
in which volatility is relatively high across all the three variables, with exchange rates moving in spite
of active intervention. They found that the de facto pegs have a remained stable throughout the last
decade although an increasing number of them shy away from an explicit commitment to a fixed
regime (fear of pegging). They also found that pure floats are associated with only relatively minor
nominal exchange rate volatility and that the recent increase in the number of de jure floats goes
hand in hand with an increase in the number of de facto dirty floats (fear of floating). In line with
9
the finding of de facto classification, Reinhart and Rogoff (2002) attempted to build non-arbitrary de
facto classification, so called natural classification. They employed an extensive data on marketdetermined parallel exchange rates, and found that the gap between de facto and de jure exchange rate
regimes is serious.
Another way to analyze the flexibilities of exchange rate is to construct the flexibility index
(Bayoumi and Eichengreen, 1998). Exchange rate or foreign reserve movements in isolation
provide a partial picture of an exchange rate regime. However, more informative indicator of
exchange rate flexibility can be found by combining exchange rates and foreign reserve behaviors
(Baig 2001 and Wang and Yang 2001). By accessing the changes in exchange rate intervention in
conjunction with exchange rate fluctuations, the degree of intervention can be measured along with
exchange rate changes. It is, however, difficult to determine that less volatility of exchange rates
means high degree of intervention since it should be considered how much internal or external
shock is mitigated by exchange rate intervention. It can be analyzed by using the flexibility index as
follows:
(2) Flexibility Index =
sdex
(sdex + sdrev ))
where sdex is the standard deviation of the log difference of exchange rate, and sdrev is the
standard deviation of changes in foreign reserves divided by lagged stock of high-powered money.
There are several factors that we should carefully consider in constructing the flexibility index
according to equation (2). The first factor is how to measure the changes in foreign reserves. It has
been known that changes in foreign reserves are not good measures to find the degree of
intervention since the changes in foreign reserves adequately reflections of intervention in the
foreign exchange market. We apply the Levy-Yeyati and Sturzengger’s methodology to define the
10
changes in foreign reserves6. First the net foreign reserves can be defined in dollar terms as:
(3) rt =
fa t - fl t - gd t
st
where, fa, fl, and gd are central bank’s foreign asset, foreign liability, and government deposit at the
central bank respectively, and s t is the nominal exchange rate. From the net foreign reserve, we can
define the standard deviation of foreign reserve divided by previous base money as following.
(4) sdrev =
∆r
high power money t _ 1
St _ 1
The flexibility index ranges from one to zero. In theory, fixed exchange rate regimes require volatile
changes in reserves, but zero or near zero volatile changes in exchange rates. Therefore, the index
should be zero or near zero. On the other hand, free-floating regimes are characterized by
substantial volatility in exchange rates with stable reserves. The index for free floating regimes
should be close to one.
Table 10 summarizes exchange rate regimes and the degree of exchange rate flexibilities in the
selected East Asian countries according to: IMF classification, Levy-Yeyati and Sturzengger’s
classification, Reinhart and Rogoff ’s natural classification, and Flexibility Index. Table 10 exhibits
several interesting points that we should point out. First, none of the classification is able to
unanimously describe the exchange rate regime for a country in the region except in bipolar cases.
For example, the fixed exchange rate regime including currency board of Hong Kong, official
dollar pegging in Malaysia, and de facto dollar pegging in China is consistent with all classification.
6
See Levy-Yeyati and Federco Stuzeneggar (1999)
11
More or less, free floating in Japan is also consistently revealed in all of the classification. However,
the intermediate regimes in East Asia classified as managed floating or freely floating in the IMF
classification have different aspects of flexibilities in exchange rate movements. For instance,
Indonesia is classified as a freely floating regime by IMF and Reinhart and Rogoff while it is
classified as an intermediate regime by Levy-Yeyati and Stuzeneggar. More vaguely, Korea is
classified as freely floating by the IMF and Reinhart and Rogoff while it is classified as a fixed
regime by Levy-Yeyati and Stuzeneggar. The disparities illustrate the gap between de jure (IMF) and
de facto classifications, and also the gap among the de facto classifications.
Second, the degree of flexibilities has been gradually reduced in the East Asian countries
although they have moved toward more flexible regimes since the Asian crisis. On one hand, more
countries in the region are classified as a freer exchange rate regime in term of the IMF
classification and Reinhart and Rogoff classification since the Asian crisis. More rigid exchange rate
movements are reflected by the flexibility index in 2002 and 2003, which indicates more foreign
exchange market intervention. Figure 4 compares the flexibility index in 1995, 1998, 2002 and 2003.
One extreme polar is a fixed regime with zero for flexibility index, and the other polar represents a
point that is normalized by the average flexibility index (0.565) between 1995 and 2003 for the US
dollar that is mostly close to truly free floating. Most of the non-bipolar cases returned to the level
of pre-crisis flexibilities or reduced the flexibility index, except for Thailand and Indonesia (see
figure 4).
In conclusion since the Asian crisis, there has been an increase in the number of countries in
East Asia that have adopted flexible exchange rate regime. However, there have also been
differences in the way that they managed exchange rates among the floaters. Regardless of de jure or
de facto exchange rate regime, major economies in East Asia have accumulated a huge amount of
foreign reserves. More than half of world foreign reserves were located in East Asia in 2003. It
12
seems that the exchange rate management regardless of exchange rate regime is more relevant than
the choice of declared exchange rate regimes in the region. At the same time, it seems that East
Asian countries are moving toward a relatively inflexible exchange rate and freer capital movements.
III. Concerns on Diversified Exchange Regimes in East Asia
The exchange rate management in East Asia differs across countries and over time. The
various approaches toward exchange rates management in East Asia can have potential negative
effect in long run exchange rate stabilities and capital account soundness. In between institutional
hard peg as a common currency and truly free floating, East Asian countries choose greater relative
exchange rate predictability with different exchange rate managements through significant
interventions and significant degrees of exchange volatility.
What problems can result from this? First, global and regional shocks affect each country
differently in the region. In this case, each economy should react differently in monetary policy. As
a result of this, more pressure on competitive intervention increases, which might be welfare
reducing in the region under certain circumstances. Therefore, increasing instability on exchange
rates might cause less intra regional trade and investment which might impede regional trade
arrangement or economic integration.
Asymmetric Responses to External Shocks
We have recently witnessed that US dollar movements have a different affect on the exchange
rates in the region. When looking around the movements of exchange rates of East Asian
currencies, we find asymmetric reaction to the US dollar depreciation. For instance, the Japanese
13
yen has appreciated against the US dollar since 2002. Also the Korean won, the Thai baht, and the
Singapore dollar appreciated against the US dollar in 2002 together with the Japanese yen, but they
have depreciated against the Japanese yen. The Indonesia rupiah has appreciated against the US
dollar and the Japanese yen while the Philippine peso has depreciated against the US dollar and the
Japanese yen. During the same time period, the Chinese yuan, Hong Kong dollar, and the Malaysian
ringgit have depreciated against the Korean won, the Thai baht, and the Singapore dollar as well as
the Japanese yen since they are pegged to the US dollar (see figure 1).
One group of countries that adopt the floating or managed floating exchange rate system
faces their home currencies’ appreciation against the US dollar since 2002. The group includes
Japan, Korea, Thailand, and Singapore. The other group consists of countries that officially adopt
de facto fix their home currencies to the US dollar. This group includes Malaysia, Hong Kong, and
China. Their exchange rates have been fixed against the US dollar in recent years. As a result, they
have been depreciating against the currencies of the former group countries, Japanese yen, Korean
won, Thai baht, and Singapore dollar due to the depreciation of the US dollar since 2002. Thus, the
dollar pegging currencies carry stress from the depreciation of the US dollar to the more flexible
exchange rate regime adopting currencies. The asymmetric reaction of the East Asian currencies to
the depreciation of the US dollar should bias relative prices of products made in East Asian
countries. The bias of relative prices among the East Asian countries might give adverse effects on
allocation of resources in terms of international trade and foreign direct investments. We might
find biased economic growth among them.
Ogawa and Ito (2002) pointed out possibilities of coordination failure in choosing exchange
rate system and exchange rate policy in a game theoretical framework as long as one country’s
choosing the dollar peg system has an adverse effect on others’ choosing their own exchange rate
system through relative price effects. Ogawa (2002b) conducted an empirical analysis on whether
14
the dollar pegging currencies gave adverse effects on other East Asian countries’ choice of
exchange rate system and exchange rate policy. They chose not a desirable exchange rate system but
the de facto dollar peg system because the dollar pegging countries kept adopting official or de facto
dollar peg systems. In other words, the monetary authorities in East Asian countries face
coordination failure in choosing desirable exchange rate system among East Asian countries.
Accordingly, it is clear that we should make regional coordination for a desirable exchange rate
regime instead of the diversified exchange rate regimes and exchange rate management.
Competitive devaluation
Due to the asymmetric responses to the US dollar movements, more pressures would be put
into competitive devaluation by market intervention in the region. As Corsetti et al. (1999) pointed
out, the use of exchange rate policy to gain competitive advantage over a country’s trading partners
has long been recognized as a major threat to the stability of the international monetary system. A
competitive devaluation as beggar-thy-neighbor policies increase output growth and employment
domestically at the expense of output growth and employment abroad. In the East Asian context, a
country’s devaluation (center) in the region, whether intended or unintended, will create more
pressures on other countries’ devaluation (periphery). This will produce more currency deviation
from equilibrium level as well as more possible future volatile exchange rate movements in the
region.
To see how much a (intended) competitive devaluation can take place in the region, we estimate
the correlation on the degree of intervention between Japan and other selected countries. To do so,
we use the measure of monthly intervention in the foreign exchange market, equation (4). If the
interventions by the Japanese authority influence the yen/dollar exchange rates, then the
15
intervention pressures on exchange rates for the periphery counties increase is reasonable
assumption. Therefore, as the pressures on competitive devaluation increase, the correlation
between center and periphery countries’ intervention would increase. Table 11 reports the
correlation between monthly intervention measure of Japan at time t and that of other countries at
time t+1. Table 10 shows that the correlation between Japanese intervention and the other East
Asian countries generally has negative sign from 1995 to 2001 with few exceptions. However, the
correlation turns into more a positive sign in 2002 and 2003, except for China. The result implies
that the current appreciation pressure for floaters in East Asia has been mitigated by the
government authorities. This will increase the stockpiling of international reserves in East Asia
since most intervention by authorities in East Asia has been conducted by direct purchase of US
dollar in the foreign exchange markets rather than indirect monetary policies.
Dilemma between asset dollarization and liability dollarization
With freer capital mobility and low inflation, major concerns over exchange management in
East Asia stand in between asset dollarization and liability dollarization. In most of the East Asian
countries, foreign assets have been accumulated in terms of the US dollar. In particular, East Asia
has experienced a rapid increase in foreign reserves since the Asian crisis. The increase in East
Asia’s foreign reserves is a result of the realization of crisis-hit countries that the lack of foreign
currency liquidity caused the currency crisis. Thereby, motivating them to expand their foreign
reserves as insurance policy. In addition, most countries in East Asia, with their export-led
economic structure, had to suppress foreign exchange rate appreciation due to the increase in net
capital flows after the crisis, and setting a policy goal of expanding their foreign reserves. However,
in the process of correcting external imbalance of the US, the dollar could be devalued and East
16
Asian countries with a considerable amount of foreign reserves in dollar denominated asset could
suffer tremendous losses.
On the contrary, liability dollarization impedes local currency depreciation to prevent the
destructive impact of sharp depreciation of the currency on the solvency of financial institutions.
Combining these two forces, countries in East Asia may be prone to rigid exchange rate movements.
Some assert that several East Asian countries may be reverting to exchange rate practices similar to
those of the pre-crisis period (Mussa et al 2000).
IV Conclusion and Policy Implication
In a spectrum of exchange rate arrangement, the choice of exchange rate regimes in East Asia
is limited, and no common exchange rate regimes seem to be viable in the foreseeable future. As an
emerging market or developing economy, most countries in East Asia lie in between two polar
extremes. Common currency with stability benefits and absence of currency mismatch is one of
the two polar extremes. However, due to the complete loss of monetary and fiscal independence,
this option remains a long-term agenda in the region. At the other extreme is a true free floating
regime with no government intervention in the foreign exchange market. The benefit is complete
monetary and fiscal independence, but this option is binding under a fear of floating.
Basket pegged or band should be one option for East Asia. It is suggested that the rigid
pegging countries should adopt a more flexible system such as an intermediate exchange rate
system that consists of both currency basket and exchange rate band. The more flexible system
utilizes an intermediate exchange rate system that is located between the free floating exchange rate
system and the dollar peg system instead of a free floating system. It is to suggest that an
intermediate exchange rate system that consists with both currency basket and exchange rate band.
17
First, under the currency basket system, the monetary authorities should not target
the US
dollar but instead a currency basket that is a composite of the US dollar, the Japanese yen, and the
euro from a viewpoint of international trade partners and FDI. East Asian countries have strong
economic relationship in terms of trade, FDI, and international finance with each other and
European countries as well as the United States. Second, under the exchange rate band system, the
monetary authorities should set a band in which the exchange rates are free floating without any
intervention in the foreign exchange market. The exchange rate band can afford room for domestic
monetary policy to the monetary authorities.
East Asian countries have strong economic relationships with each other within the intraregion as well as the United States and European countries. It is desirable for East Asian countries
to stabilize exchange rates among the intra-regional currencies and to stabilize their exchange rates
against outside currencies such as the US dollar and the euro. The monetary authorities of East
Asian countries should coordinate their exchange rate policy to their exchange rates against the
outside currencies in order to stabilize both intra-regional exchange rates and their exchange rate
with outside currencies at the same time. They should care about not only the US dollar and the
euro but also the Japanese yen because Japan has a larger portion in intra-regional economic
relation.
18
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Ogawa, E., 2002a, “Should East Asian countries return to a dollar peg again?” in Peter Drysdale
and Kenichi Ishigaki eds. East Asian Trade and Financial Integration: New Issues, Asia Pacific
Press, 159-184.
Ogawa, E. 2002b, “Economic interdependence and international coordination in East Asia,” in
Exchange
Rate
Regimes
for
Asia
(Kobe
Research
Project)
Ministry
of
Finance.
(http://www.mof.go.jp/jouhou/kokkin/tyousa/tyou042f.pdf),
19
Ogawa, E. and T. Ito, 2002, “On the desirability of a regional basket currency arrangement,” Journal
of the Japanese and International Economies, vol. 16, No. 3, 317-334.
Reinhart, C., and K. S. Rogoff, 2002, “The Modern History of Exchange Rate Arrangements: A
Reinterpretation”, NBER working paper 8963.
Wang, W., and D. Y. Yang, 2001, “Searching for an Appropriate Exchange Rate Regime” Journal of
International Economic Studies, No. 1, pp 149-194.
20
<Table 1> Data Statistics on Nominal Exchange Rates (1990.1 – 1996.12)
China
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
Jarque-Bera
Probability
Observations
1.871
1.753
2.164
1.552
0.233
0.125
1.263
10.778
0.005
84.000
Hong
Kong
2.047
2.046
2.055
2.044
0.003
1.205
3.254
20.548
0.000
84.000
Indonesia
Japan
Korea
Malaysia
Philippines
Singapore
Thailand
Taiwan
7.646
7.646
7.776
7.498
0.078
-0.104
2.036
3.402
0.182
84.000
4.753
4.726
5.071
4.421
0.154
0.034
2.264
1.910
0.385
84.000
6.648
6.663
6.738
6.531
0.049
-0.608
2.308
6.848
0.033
84.000
0.957
0.944
1.026
0.892
0.037
0.347
1.772
6.966
0.031
84.000
3.261
3.266
3.395
3.115
0.057
-0.639
3.457
6.449
0.040
84.000
0.459
0.476
0.631
0.329
0.091
0.093
1.891
4.426
0.109
84.000
3.231
3.230
3.258
3.202
0.012
-0.166
3.113
0.430
0.806
84.000
3.277
3.278
3.320
3.204
0.031
-0.538
2.222
6.179
0.046
84.000
<Table 2> Data Statistics on Nominal Exchange Rates (1999.1 –2004.4)
China
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
Jarque-Bera
Probability
Observations
2.114
2.114
2.114
2.114
0.000
NA
NA
NA
NA
64.000
Hong
Kong
2.052
2.054
2.054
2.046
0.002
-1.100
2.677
13.184
0.001
64.000
Indonesia
Japan
Korea
Malaysia
Philippines
Singapore
Thailand
Taiwan
9.083
9.078
9.365
8.814
0.116
-0.002
3.305
0.248
0.883
64.000
4.753
4.772
4.897
4.627
0.069
0.023
2.214
1.654
0.437
64.000
7.096
7.091
7.191
7.009
0.052
0.241
2.145
2.570
0.277
64.000
1.335
1.335
1.335
1.335
0.000
NA
NA
NA
NA
64.000
3.878
3.936
4.032
3.638
0.129
-0.699
1.961
8.083
0.018
64.000
0.557
0.554
0.615
0.513
0.026
0.409
2.385
2.791
0.248
64.000
3.719
3.737
3.822
3.607
0.064
-0.286
1.805
4.680
0.096
64.000
3.504
3.511
3.559
3.415
0.043
-0.552
2.051
5.660
0.059
64.000
<Table 3> Data Statistics on Real Exchange Rates (1990.1 - 1996.12)
China
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
Jarque-Bera
Probability
Observations
1.486
1.401
1.858
1.197
0.181
0.352
1.928
5.751
0.056
84.000
Hong
Kong
2.069
2.052
2.245
1.942
0.086
0.475
2.158
5.641
0.060
84.000
Indonesia
Japan
Korea
Malaysia
Philippines
Singapore
Thailand
Taiwan
8.466
8.466
8.526
8.395
0.036
-0.131
1.595
7.150
0.028
84.000
4.606
4.613
4.868
4.310
0.127
-0.162
2.492
1.267
0.531
84.000
6.772
6.779
6.818
6.702
0.033
-0.653
2.420
7.149
0.028
84.000
1.006
0.989
1.095
0.927
0.051
0.371
1.719
7.672
0.022
84.000
3.590
3.590
3.850
3.422
0.118
0.154
1.932
4.320
0.115
84.000
0.372
0.388
0.524
0.249
0.080
0.064
1.817
4.955
0.084
84.000
3.353
3.366
3.426
3.283
0.044
-0.250
1.718
6.624
0.036
84.000
3.242
3.246
3.301
3.170
0.032
-0.291
2.320
2.805
0.246
84.000
21
<Table 4> Data Statistics on Real Exchange Rates (1999.1 – 2004.4)
China
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
JarqueBera
Probability
Observations
Indonesia
Japan
Korea
Malaysia
Philippines
Singapore
Thailand
Taiwan
2.128
2.121
2.172
2.064
0.028
-0.031
2.205
1.536
Hong
Kong
2.090
2.097
2.212
1.938
0.075
-0.287
2.154
2.527
9.004
9.000
9.322
8.815
0.126
0.391
2.450
2.210
4.787
4.816
4.950
4.602
0.096
-0.293
1.919
3.653
7.083
7.069
7.178
7.006
0.052
0.374
1.852
4.537
1.341
1.343
1.365
1.307
0.016
-0.559
2.366
3.995
3.840
3.887
3.958
3.647
0.103
-0.697
1.913
7.556
0.577
0.597
0.644
0.494
0.046
-0.370
1.661
5.657
3.731
3.763
3.832
3.573
0.079
-0.674
1.980
6.901
3.526
3.556
3.628
3.409
0.072
-0.190
1.409
6.469
0.464
58.000
0.283
58.000
0.331
58.000
0.161
58.000
0.103
58.000
0.136
58.000
0.023
58.000
0.059
58.000
0.032
58.000
0.039
58.000
<Table 5> Nominal Exchange Rates Correlation Matrix (1990.1-1996.12)
China
HK
IND
Japan
Korea
MAL
PHI
SING
THAI
Taiwan
China
1.000
-0.664
0.901
-0.851
0.637
-0.566
0.148
-0.906
-0.615
0.204
HK
IND
Japan
Korea
MAL
PHI
SING
THAI
Taiwan
1.000
-0.754
0.697
-0.832
0.622
-0.184
0.719
0.473
0.160
1.000
-0.821
0.773
-0.735
0.215
-0.970
-0.543
0.196
1.000
-0.647
0.685
-0.252
0.874
0.861
0.011
1.000
-0.617
0.298
-0.693
-0.362
-0.102
1.000
0.122
0.780
0.607
0.173
1.000
-0.151
-0.185
0.274
1.000
0.689
-0.124
1.000
0.138
1.000
<Table 6> Nominal Exchange Rates Correlation Matrix (1999.1-2004.4)
China
HK
IND
Japan
Korea
MAL
PHI
SING
THAI
Taiwan
China
1.000
N.A.
N.A.
N.A.
N.A.
1.000
N.A.
N.A.
N.A.
N.A.
HK
IND
Japan
Korea
MAL
PHI
SING
THAI
Taiwan
1.000
0.546
0.348
0.309
0.000
0.553
0.600
0.787
0.325
1.000
0.591
0.703
0.000
0.537
0.816
0.817
0.509
1.000
0.782
0.000
0.284
0.805
0.569
0.720
1.000
0.000
0.347
0.739
0.677
0.664
1.000
N.A.
N.A.
N.A.
N.A.
1.000
0.492
0.691
0.734
1.000
0.812
0.623
1.000
0.626
1.000
22
<Table 7> Real Exchange Rates Correlation Matrix (1990.1-1996.12)
China
HK
IND
Japan
Korea
MAL
PHI
SING
THAI
Taiwan
China
1.000
-0.820
-0.844
-0.567
-0.541
-0.695
-0.836
-0.879
-0.905
-0.118
HK
IND
1.000
0.836
0.710
0.386
0.872
0.874
0.910
0.896
0.290
1.000
0.713
0.632
0.764
0.852
0.901
0.915
0.118
Japan
1.000
0.388
0.674
0.591
0.792
0.702
0.417
Korea
1.000
0.373
0.510
0.602
0.650
-0.082
MAL
1.000
0.886
0.860
0.840
0.474
PHI
1.000
0.895
0.886
0.386
SING
THAI
1.000
0.971
0.328
1.000
0.186
Taiwan
1.000
<Table 8> Real Exchange Rates Correlation Matrix (1999.1-2004.4)
China
HK
IND
Japan
Korea
MAL
PHI
SING
THAI
Taiwan
China
1.000
0.955
-0.418
0.668
-0.018
0.866
0.817
0.809
0.642
0.827
HK
IND
Japan
Korea
MAL
PHI
SING
THAI
Taiwan
1.000
-0.288
0.719
0.084
0.928
0.914
0.880
0.751
0.866
1.000
-0.007
0.578
-0.075
0.047
0.041
0.309
-0.221
1.000
0.567
0.641
0.740
0.892
0.741
0.911
1.000
0.181
0.313
0.429
0.563
0.372
1.000
0.942
0.855
0.830
0.801
1.000
0.905
0.919
0.843
1.000
0.864
0.896
1.000
0.746
1.000
<Table 9> Estimation Result of Equation (1) by recursive Least Squares
Mean
Median
Maximum
Minimum
Std. Dev.
Skewness
Kurtosis
Jarque-Bera
Probability
China
0.945
0.957
0.983
0.876
0.033
-0.648
2.234
14.737
0.001
HK
0.996
0.995
1.009
0.991
0.003
1.649
6.170
135.99
0.000
IND
0.758
0.954
0.994
0.368
0.240
-0.238
1.157
23.550
0.000
Korea
0.903
0.900
1.008
0.742
0.075
-0.104
1.667
11.830
0.003
23
MAL
0.832
0.836
0.918
0.730
0.043
0.046
2.572
1.243
0.537
PHI
1.003
1.000
1.140
0.904
0.067
0.034
1.659
11.712
0.003
SING
0.658
0.657
0.721
0.560
0.035
-0.946
3.896
28.493
0.000
THAI
0.732
0.683
0.830
0.592
0.084
0.036
1.122
22.951
0.000
Taiwan
0.874
0.847
1.042
0.806
0.069
0.742
1.998
20.857
0.000
<Table 10> Exchange Regimes and Flexibilities in East Asia
China
Hong
Kong
Indonesia
Japan
Korea
Malaysia
Philippines
Singapore
Thailand
Taiwan
U.S. (FI)
IMF
Levy
RR
Flexibility
index
IMF
Levy
RR
Flexibility
index
IMF
Levy
RR
Flexibility
index
IMF
Levy
RR
Flexibility
index
IMF
Levy
RR
Flexibility
index
IMF
Levy
RR
Flexibility
index
IMF
Levy
RR
Flexibility
index
IMF
Levy
RR
Flexibility
index
IMF
Levy
RR
Flexibility
index
IMF
Levy
RR
Flexibility
index
1995
3
NA
4
-
1996
3
NA
4
-
1997
3
NA
4
-
1998
3
NA
4
-
1999
3
NA
4
0.0
2000
3
NA
4
0.0
2001
3
4
0.0
2002
3
0.0
2003
3
0.0
2
Fix*
2
-
2
Fix*
2
-
2
Fix
2
0.007
2
Fix
2
0.003
2
Fix2
2
0.004
2
Fix2
2
0.006
2
2
0.0
2
0.0
2
0.0
7
Interm*
7
0.015
7
Interm*
7
0.053
8
Interm*
14/13
0.311
8
Interm
14/13
0.652
8
Interm*
13
0.309
8
Interm*
13
0.301
7
13
0.593
7
-
7
-
0.395
0.183
8
Float
13
0.552
8
Float
13
0.283
8
Float
13
0.381
8
Float
13
0.562
8
Float
13
0.363
8
Float
13
0.309
8
13
0.381
8
0.272
8
0.339
7
Interm*2
7
0.101
7
Fix
7
0.065
8
Interm*
14
0.408
8
Interm*
13
0.219
8
Fix
13
0.147
8
Fix
13
0.107
8
13
0.163
8
0.140
8
0.100
7
Float2
8
0.193
7
Interm*2
8
0.201
7
Float
13
0.385
3
Interm*
4
0.351
3
Fix+
4
0.0
3
Fix+
4
0.0
3
4
0.0
3
0.0
3
0.0
8
Float2
4
0.323
8
Fix2
4
0.018
8
Float
14/13
0.493
8
Float
12
0.591
8
Float2
12
0.301
8
Float
12
0.338
8
12
0.288
8
0.126
8
0.187
7
Fix3
11
0.104
7
Fix3
11
0.045
7
Interm*
11
0.268
7
Float
12
0.194
7
Float2
12
0.091
7
Float
12
0.078
7
12
0.148
7
0.074
7
0.086
3
Interm*2
4
0.101
3
Fix+
4
0.083
8
Interm*
14/13
0.278
8
Intern*
12
0.472
8
Float
12
0.391
7
Float
12
0.371
7
12
0.364
7
0.258
7
0.272
NA
NA
NA
0.284
NA
NA
NA
0.136
NA
NA
NA
0.480
NA
NA
NA
0.517
NA
NA
NA
0.244
NA
NA
NA
0.258
NA
NA
NA
0.243
NA
NA
NA
0.139
NA
NA
NA
0.116
0.559
0.617
0.246
0.393
0.445
0.490
0.755
0.739
0.840
Note. IMF classification: Exchange arrangement with no separate legal tender = 1, Currency board
arrangement = 2, Conventional pegged arrangement = 3, Pegged exchange rate within horizontal
bands = 4, Crawling peg = 5, Crawling band = 6, Managed floating with no pre-announced path = 7,
Independently floating = 8.
Levy: NA means that classification variable is not available. Fix+: inconclusive, Fix*:uncontroversial,
24
Interm: dirty, Interm*: dirty/crawling peg, 2: classified in 2nd round, 3: outliers.
Reinhart and Rogoff (find grid): No separate legal tender = 1, Pre announced peg or currency board
arrangement = 2, Pre announced horizontal band that is narrower than or equal to +/- 2% = 3, De
facto peg = 4, Pre announced crawling peg = 5, Pre announced crawling band that is narrower than or
equal to +/- 2% = 6, De facto crawling peg = 7, De facto crawling peg that is narrower than or equal
to +/- 2% = 6, De facto crawling peg = 8, Pre announced crawling ban that is wide than or equal to
+/- 2% = 9, De facto crawling peg that is narrower than or equal to +/- 5% = 10, Moving band that
is narrower than or equal to +/- 2% = 11, Managed floating = 12, Free floating = 13, Freely falling =
14.
<Table 11> Intervention correlation between Japan and other selected countries
1995
1996
1997
1998
China
1999
2000
2001
2002
2003
-0.188 -0.646 -0.078 -0.461 -0.246
HK
-0.166 -0.311 -0.198 -0.126 -0.296
0.850
-0.634 -0.013
0.158
-0.007
-0.266
0.007
-0.079 -0.705 -0.025
0.042
-0.691 -0.707 -0.205 -0.085
0.440
ML
-0.302
-0.050 -0.310
PH
-0.288 -0.187 -0.393 -0.321
0.144
SN
-0.331 -0.259 -0.147
0.368
-0.658 -0.384 -0.069
0.192
0.159
-0.652 -0.309
0.089
-0.503 -0.378 -0.307
0.053
0.553
0.024
0.459
0.830
IND
Korea
Thailand
Taiwan
0.318
0.420
0.119
0.119
0.469
-0.414 -0.147 -0.129 -0.243
25
0.407
0.160
0.293
0.060
0.207
-0.438 -0.194 -0.192
0.723
0.080
-0.072
-0.489
<Figure 1> Nominal Exchange Rate Movements (1999 =100)
160
China
150
Hong Kong
140
Indonesia
130
Japan
120
Korea
Malaysia
110
Philippines
100
Singapore
90
Thailand
Taiwan
19
99
M
19 1
99
M
20 7
00
M
20 1
00
M
20 7
01
M
20 1
01
M
20 7
02
M
20 1
02
M
20 7
03
M
20 1
03
M
20 7
04
M
1
80
<Figure 2> Real Exchange Rates Movements (1999=100)
150
China
140
Hong Kong
130
Indonesia
Japan
120
Korea
Malaysia
110
Philippines
Singapore
100
Thailand
90
Taiwan
19
99
M
19 1
99
M
20 7
00
M
20 1
00
M
20 7
01
M
20 1
01
M
20 7
02
M
20 1
02
M
20 7
03
M
20 1
03
M
20 7
04
M
1
80
26
<Figure 3> Changes on coefficient of the US dollar weight
1.8
1.06
1.6
1.04
1.4
1.02
1.2
1.0
1.00
0.8
0.98
0.6
0.96
0.4
0.94
0.2
1992
1994
1996
1998
2000
1992
2002
1996
1998
2000
2002
Recursive C(2) Estimates in Hong Kong
± 2 S.E.
Recu rsive C(2 ) Est im at es in Ch in a
± 2 S.E.
1.6
1994
1.3
1.2
1.2
1.1
1.0
0.8
0.9
0.8
0.4
0.7
0.6
0.0
0.5
-0.4
0.4
1992
1994
1996
1998
2000
2002
1992
Recursive C(2) Estimates in Indonesia
± 2 S.E.
1994
1996
1998
2000
2002
Recursive C(2) Estimates in Korea
± 2 S.E.
1.6
1.1
1.0
1.4
0.9
1.2
0.8
0.7
1.0
0.6
0.8
0.5
0.6
0.4
1992
1994
1996
1998
2000
1992
2002
1994
1996
1998
2000
2002
Recursive C(2) Estimates in Philliphines
± 2 S.E.
Recursive C(2) Estimates in Malaysia
± 2 S.E.
27
.9
1.0
0.9
.8
0.8
0.7
.7
0.6
.6
0.5
0.4
.5
0.3
.4
0.2
1992
1994
1996
1998
2000
2002
1992
Recursive C(2) Estimates in Singapore
± 2 S.E.
1.2
1.1
1.0
0.9
0.8
0.7
0.6
1994
1996
1998
2000
1996
1998
2000
2002
Recursive C(2) Estimates in Thailand
± 2 S.E.
1.3
1992
1994
2002
Recursive C(2) Estimates in Taiwan
± 2 S.E.
28
<Figure 4> Flexibility index for selected countries in East Asia
1.4
1.2
1
0.8
0.6
0.4
0.2
1995
1998
29
2002
2003
Ta
iw
an
nd
Th
ai
la
re
s
Si
ng
ap
o
Ph
ilip
in
e
ia
ys
al
a
M
Ko
re
a
pa
n
Ja
In
do
ne
si
a
ng
Ko
H
on
g
C
hi
na
0