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Exchange rate regime switching in Malaysia and Singapore in response to China’s move to a basket peg: A DSGE analysis

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  • Yoshino, Naoyuki
  • Kaji, Sahoko
  • Asonuma, Tamon

Abstract

Motivated by the observation that when China broke from its US dollar peg in 2005, Malaysia and Singapore likewise loosened their currency ties to the US dollar, this paper considers how these two countries might best respond to a hypothetical transition by China to a new basket peg regime. We specify five alternative exchange rate strategies that encompass fixed, basket, and floating regimes and gradual versus sudden transitions. To project outcomes for macroeconomic variables under these alternative regimes, we apply a dynamic stochastic general equilibrium (DSGE) model of a small open economy and incorporate exogenous shocks as actually occurred from 2005 Q1 to 2014 Q4. We then compare the strategies based on values of a cumulative loss function defined on the output gap, the inflation rate, and the real effective exchange rate. The exercise reveals that a gradual adjustment to a basket peg with long-term optimal weights is the first-best policy for both countries, where optimal weights are derived to minimize the loss function. Further, both a sudden shift to a basket peg with optimal weights and a sudden shift to a floating rate regime are superior to maintaining the dollar peg in Malaysia, but not to maintaining the existing basket peg in Singapore.

Suggested Citation

  • Yoshino, Naoyuki & Kaji, Sahoko & Asonuma, Tamon, 2016. "Exchange rate regime switching in Malaysia and Singapore in response to China’s move to a basket peg: A DSGE analysis," Journal of Asian Economics, Elsevier, vol. 46(C), pages 17-37.
  • Handle: RePEc:eee:asieco:v:46:y:2016:i:c:p:17-37
    DOI: 10.1016/j.asieco.2016.08.006
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    References listed on IDEAS

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    Keywords

    F33; F41; F42; Basket peg; China; dynamic transition analysis; East Asia; exchange rate regime; transition path;

    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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