• Exchange rates and currency crises

Exchange rates and currency crises

This paper contributes to the ongoing debate about the appropriate exchange rate system for Asian economies, which has erupted since the Asian financial crisis. It 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 disaggregation for each economy, macroeconomic features, and the linkages between countries in the region through international trade of goods and financial assets.

As this paper demonstrates, the choice of any exchange rate regime for a given country depends on the special characteristics of that country and on the policy choices made by neighboring countries. It also depends on the ultimate preferences of policymakers. Furthermore it depends on the nature of shocks. What type of shocks will dominate in the future, still has to be established.

Based on the empirical evidence gathered, the study finds that, both the yen block and the Asian currency union (ACU) tend to be dominated by floating exchange rates and a basket peg over most combinations of shock for most countries. Furthermore, the study shows that it is difficult to separate the performance of the basket peg to the $US, Euro and Yen relative to a floating exchange rate when only considering the impact on output variability, although the floating exchange rate always dominates the basket peg in terms of inflation variability.

An important lesson to be drawn from this paper is, that in practice it will be of substantial importance for policymakers to understand how to adjust the exchange rate regime quickly in the event that a shock occurs for which the regime they have adopted doesn’t perform well. [adapted from author]

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