Dynamic Analysis of the Exchange Rate Regime: Policy Implications for Emerging Countries in East Asia

• Author: Sahoko Kaji,Naoyuki Yoshino,Tamon Asonuma
• Published date: 01 August 2015
• Date: 01 August 2015
• DOI: http://doi.org/10.1111/rode.12163

Dynamic Analysis of the Exchange Rate Regime:

Policy Implications for Emerging Countries in

East Asia

Naoyuki Yoshino, Sahoko Kaji, and Tamon Asonuma*

Abstract

This paper discusses exchange rate policies in East Asia. In particular, we explore whether actual policies

that have been implemented by East Asian countries after the Asian Financial Crisis follow or deviate from

theoretically “desirable” policies over the medium and long terms. On theoretical analysis, we show the

relative superiority of a basket-peg regime with the basket weight rule when compared with a floating

regime implementing the interest rate rule or money supply rule. For countries that currently adopt a fixed

exchange rate regime, they would be better off shifting toward either a basket-peg or a floating regime over

the medium term. A shift to a basket peg is more preferred when compared with a shift to a floating regime

when the exchange rate fluctuations are large.

1. Introduction

From the 1990s to the present, East Asian countries have witnessed intensive debates

on desirable exchange rate regimes in the region. Before the Asian Financial Crisis, a

de facto dollar peg had been acknowledged as an appropriate regime promoting trade

and capital inflows despite potential welfare losses associated with loss in their mon-

etary autonomy.

However, since the outset of the Asian Financial Crisis, adoption of a de facto

dollar peg has been blamed as one of two major culprits. Large fluctuations of the

exogenous exchange rate, such as the dollar–yen rate negatively affected the econo-

mies through the yen rate, though the dollar rate was kept fixed. In fact, some East

Asian countries deviated from a de facto dollar peg and increased flexibility in

exchange rate movements for adjustment of external imbalances. The other culprit

was a discrepancy in maturity between lending and borrowing by financial institutions

in East Asian economies.

Against this background, Kawai (2004), Ito et al. (1998), Ito and Park (2003),

Yoshino et al. (2004b) and Ogawa and Ito (2002) recommend that East Asian coun-

tries embrace a basket-peg regime. A rationale for adopting a basket-peg regime is

that for countries with close economic relationships with multiple partners such

as the EU, Japan and the USA, exchange rate stabilization vis-à-vis a basket compris-

ing these currencies is beneficial, because countries can avoid large fluctuations

in one single exchange rate.1Furthermore, a floating regime is also considered to be a

* Yoshino: Asian Development Bank Institute, Kasumigaseki Building 8F, 3-2-5 Kasumigaseki Chiyoda-

Ku, Tokyo, 100-6008, Japan. Tel: +81-3-3593-5527; Fax: +81-3-3593-5571; E-mail:nyoshino@adbi.org. Kaji:

Department of Economics, Keio University. Asonuma: International Monetary Fund, 700 19th Street,

N.W. Washington, DC 20431, USA. E-mail: tasonuma@imf.org. The authors wish to thank the editor and

anonymous referee for comments and suggestions. The views expressed in this paper are those of the

authors and should not attributed to the Asian Development Bank, the International Monetary Fund, their

Executive Boards or their managements.

Review of Development Economics, 19(3), 624–637, 2015

DOI:10.1111/rode.12163

© 2015 John Wiley & Sons Ltd