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Real Effects of Movements in Nominal Exchange Rates: Application to the Asian Crisis

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    Abstract

    This paper analyzes the ad hoc decision of three Asian countries to peg their currency to the U.S. dollar prior to the Asian crisis. It uses the Sjaastad model to estimate the optimal basket weights for Thailand, Korea, and Singapore. The analysis in this paper differs from the optimal basket research since we are not searching for an ad hoc optimal basket; rather, the basket is the solution to the problem. For Thailand and Korea, the correct weights of the dollar in the basket are estimated to be 44 and 65 percent, respectively, which differ significantly from the actual weight of 100 percent for the U.S. dollar in their currency basket prior to the 1997 Asian crisis. Singapore, with a weight of 85 percent for the U.S. currency, is closer to a dollar peg, and therefore was less affected by the large depreciation of the European currencies and the yen toward the dollar that occurred prior to the Asian exchange rate crisis. Besides the fact that Singapore had better economic fundamentals prior to the crisis, the fact that the optimal basket for that country is closer to a dollar peg is an additional reason why its economy was less severely hit by the crisis.

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    Bibliographic Info

    Article provided by Universidad del CEMA in its journal Journal of Applied Economics.

    Volume (Year): VI (2003)
    Issue (Month): (November)
    Pages: 341-359

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    Handle: RePEc:cem:jaecon:v:6:y:2003:n:2:p:341-359

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    Keywords: optimum currency area; Asian crisis; exchange rate basket; currency peg;

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    1. Bhandari, Jagdeep S., 1985. "The flexible exchange basket: a macroeconomic analysis," Journal of International Money and Finance, Elsevier, Elsevier, vol. 4(1), pages 19-41, March.
    2. Reinhart, Carmen & Kaminsky, Graciela, 2002. "Financial markets in time of stress," MPRA Paper 13869, University Library of Munich, Germany.
    3. June Flanders, M. & Tishler, Asher, 1981. "The role of elasticity optimism in choosing an optimal currency basket with applications to Israel," Journal of International Economics, Elsevier, Elsevier, vol. 11(3), pages 395-406, August.
    4. Ito, Takatoshi & Ogawa, Eiji & Sasaki, Yuri Nagataki, 1998. "How Did the Dollar Peg Fail in Asia?," Journal of the Japanese and International Economies, Elsevier, Elsevier, vol. 12(4), pages 256-304, December.
    5. Flanders, M June & Helpman, Elhanan, 1979. "An Optimal Exchange Rate Peg in a World of General Floating," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 46(3), pages 533-42, July.
    6. Larry A. Sjaastad, 1998. "Why PPP Real Exchange Rates Mislead," Journal of Applied Economics, Universidad del CEMA, Universidad del CEMA, vol. 0, pages 179-207, November.
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