Which Exchange Rate Regime for Asia?

Hong-Giang Le and Warwick J. McKibbin
Warwick McKibbin
Warwick J. McKibbin Former expert - Economic Studies, Center on Regulation and Markets, Distinguished Professor of Economics & Public Policy - Crawford School of Public Policy, The Australian National University

February 1, 2004


Following the 1997 economic crisis in Asia there is a continuing debate on the appropriate exchange rate regime for Asian economies. A number of alternative exchange rate regimes have been proposed but there has been little empirical assessment of the consequences of the alternatives for the individual Asian economies. This paper offers some preliminary empirical evidence on the impacts of alternative regimes using a global empirical model containing considerable detail on individual Asian economies including both sectoral dis-aggregation for each economy, macroeconomic features, and the linkages between countries in the region through international trade of goods and financial assets.

In evaluating the performance of alternative exchange rate arrangements in Asia for output and inflation variability, this paper considers a number of shocks. The exchange rate regimes compared are floating exchange rates throughout Asia (with each central bank targeting inflation) and three forms of fixed exchange rates: a basket peg in which each Asian economy pegs their exchange rate to a basket of the Euro, $US and Yen (with Japan pegging to a basket of the Euro and $US); a Yen zone in which each Asian economy pegs their exchange rate to the Yen (and the Bank of Japan targets inflation); and an Asian Currency Unit in which a single currency circulates in Asia and an Asian central bank targets average Asia-wide inflation. The shocks considered are shocks to aggregate demand, aggregate supply and economy wide risk that are either global, Asia wide or country specific.

Not surprisingly, given the empirical literature for industrial economies from the last two decades, we find that the appropriate exchange rate regime varies across countries depending on, amongst other things, the economic structure of each country as well as the nature of the shocks hitting each economy, and the target variables that policymakers care about. No regime dominates for all shocks but the regimes of floating and a basket peg to the $US, Euro and yen generally perform better than the Asian currency union on Yen zone regimes.