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Exchange Rate Cooperation in East Asia – Why a Basket Approach may be best

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  • Peter Wilson

    (SCAPE)

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    Abstract

    In the aftermath of the Asian financial crisis, the issue of the choice of exchange rate regime for East Asian (EA) countries re-emerged. The crisis had demonstrated, amongst other things, that unilateral exchange rate regimes (including de facto dollar pegging) hadnt coped very well in the 1990s faced with massive capital inflows into the region (Kwan et al., 1998), with the possible exceptions of Singapore and Taiwan. The immediate response to the crisis was that a corner solution might be better. Either keep convertibility and fix the currency, preferably backed up with a currency board, but abandon monetary independence; or keep monetary policy and convertibility but abandon currency management and adopt a free float. But a hard peg is perceived to be too rigid for most countries in EA and the potential costs of a clean float are seen to be too great for emerging economies with weak financial infrastructure because of the risks of serious currency misalignment and destabilising speculation. The objective of this paper is to address some of these counterfactuals by looking at the impact of alternative exchange rate regimes on the volatility of the NEER and the bilateral rate against the US$ for nine EA countries after the Asian financial crisis. 9 Our counterfactuals include a UBP, a CBP, and a hard peg against the US$, but in contrast to previous counterfactual exercises, such as Williamson (1998a) and Ohno (1999) which compute the weights for effective exchange rates on the basis of simple bloc aggregates, we apply a more disaggregated methodology using a larger number of trade partners. We also utilize ARCH/GARCH techniques to obtain estimates of heteroskedastic variances to better capture the time-varying characteristics of volatility for the actual and simulated exchange rate regimes.

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    Bibliographic Info

    Paper provided by East Asian Bureau of Economic Research in its series Macroeconomics Working Papers with number 22586.

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    Date of creation: Jan 2007
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    Handle: RePEc:eab:macroe:22586

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    Postal: JG Crawford Building #13, Asia Pacific School of Economics and Government, Australian National University, ACT 0200
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    Related research

    Keywords: East Asian; Asian financial crisis aftermath; exchange rate;

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    References

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    1. Peter B. Clark & Shang-Jin Wei & Natalia T. Tamirisa & Azim M. Sadikov & Li Zeng, 2004. "A New Look at Exchange Rate Volatility and Trade Flows," IMF Occasional Papers 235, International Monetary Fund.
    2. Luci Ellis, 2001. "Measuring the Real Exchange Rate: Pitfalls and Practicalities," RBA Research Discussion Papers rdp2001-04, Reserve Bank of Australia.
    3. Reinhart, Carmen & Calvo, Guillermo, 2002. "Fear of floating," MPRA Paper 14000, University Library of Munich, Germany.
    4. Yoshino, Naoyuki & Kaji, Sahoko & Suzuki, Ayako, 2004. "The basket-peg, dollar-peg, and floating: A comparative analysis," Journal of the Japanese and International Economies, Elsevier, vol. 18(2), pages 183-217, June.
    5. Hoe Ee Khor & Jason Lee & Edward Robinson & Saktiandi Supaat, 2007. "Managed Float Exchange Rate System: The Singapore Experience," The Singapore Economic Review (SER), World Scientific Publishing Co. Pte. Ltd., vol. 52(01), pages 7-25.
    6. Graham Bird & Ramkishen Rajan, 2002. "Optimal currency baskets and the third currency phenomenon: exchange rate policy in Southeast Asia," Journal of International Development, John Wiley & Sons, Ltd., vol. 14(8), pages 1053-1073.
    7. Ramikishen Rajan, 2002. "Exchange Rate Policy Options for Post-crisis Southeast Asia: Is There a Case for Currency Baskets?," The World Economy, Wiley Blackwell, vol. 25(1), pages 137-163, 01.
    8. Lafrance, Robert & Osakwe, Patrick & St-Amant, Pierre, 1998. "Evaluating Alternative Measures of the Real Effective Exchange Rate," Working Papers 98-20, Bank of Canada.
    9. Ramkishen S. Rajan, 2006. "Monetary and Financial Cooperation in Asia : Emerging Trends and Prospects," Finance Working Papers 22125, East Asian Bureau of Economic Research.
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