Exchange Rate Arrangements in East Asia: Lessons from the 1997-98 Currency Crisis

This paper examines the evolution of exchange rate arrangements in East Asia's emerging market economies over the last 10 years. It considers both "official" and "observed" exchange rate arrangements in these economies from an international comparative perspective. By focusing on the roles of the dollar, the yen, and the euro as anchor currencies for exchange rate stabilization, the paper claims that the dollar played a dominant role as a de jure or de facto anchor for emerging East Asia until the 1997-98 currency crisis. During the crisis, the dollar's dominance naturally declined in affected East Asia as a result of a general shift to more flexible exchange rate arrangements. In the post-crisis period, the dollar has regained prominence in some countries (notably in Malaysia), while its dominance has been reduced and exchange rate flexibility has risen in others ( notably in Indonesia). Interesting is the observation that Korea and Thailand appear to have shifted to a de facto currency basket arrangement with significant weights on the dollar and the yen, similar to Singapore 's managed floating arrangement. This paper also considers what may be a desirable currency system for the region. Given the high volatility of yen/dollar exchange rates and partner diversity of trade and foreign direct investment (FDI) relationships, it claims that the emerging East Asian economies would be better off stabilizing their currencies to a balanced currency basket in which the dollar, the yen, and the euro play equally important roles. For infra-regional exchange rate stability, greater coordination on the currency basket policy would be desirable, and this needs to be supported by regional policy dialogue and financing mechanisms.

Reform of the International Financial Architecture: An Asian Perspective

The paper attempts to evaluate whether the international financial architecture is adequate for maintaining the financial stability of the East Asian economies by summarizing the lessons learned from the Asian financial crisis of 1997-1998 and the global financial crisis of 2007-2009 and reviewing the progress being made to enhance the effectiveness of the international financial architecture in crisis prevention, management and resolution. The paper finds that the international community had to experience the two crises before seriously starting to work on the reform of the international financial architecture. Facing the global financial crisis, the international community has responded by making the G20 Summit the premier forum for international economic and financial cooperation, creating a potentially more powerful Financial Stability Board, and augmenting the financial resources of the IMF. The paper concludes, however, that the international financial architecture remains inadequate for the needs of many emerging market economies, including in East Asia. International Monetary Fund surveillance—particularly that of systemically important economies (such as the United States, the United Kingdom and the Euro Area)—is ineffective and its governance structure is heavily biased towards Europe and the United States. International liquidity support is insufficient in assisting countries with sound economic and financial management that are hit by externally driven crises. No international agreements exist on external (sovereign) debt restructuring, or on the cross-border resolution of insolvent, internationally active financial firms for fair burden sharing of losses between creditors and debtors, or among different national authorities. The paper emphasizes the importance of a well-functioning regional financial architecture to complement and strengthen the global financial architecture. It offers advice for East Asian authorities to focus on: (i) the establishment of resilient national financial systems, including local-currency bond markets; (ii) integration of national financial markets to facilitate the mobilization of regional savings for regional investment (in infrastructure and small- and medium-sized enterprises); (iii) enhancement of regional liquidity (Chiang Mai Initiative Multilateralization) and economic surveillance mechanisms; and (iv) regional exchange rate policy coordination to achieve sustained economic growth without creating macroeconomic and financial instability.asian financial crisis; global financial crisis; crisis prevention; management and resolution; the imf; the financial stability board; regional financial architecture

Reform of the Japanese Banking System

Japan has experienced a decade-long economic stagnation with a distressed banking sector in the 1990s. The absence of a credit culture to rigorously assess and price credit risks of borrowers, aggravated by weak prudential and supervisory frameworks, in the 1980s, the collapse of the asset price bubble in the early 1990s, and the lack of decisive, comprehensive strategy to address the banking sector problem at an early stage were largely responsible for the emergence of banking sector problems. All of these allowed a systemic banking crisis to emerge in 1997-98 and a large output loss during 1998-2002. The crisis ultimately prompted the government to take a more aggressive policy to tackle the problem. Sufficient progress has been made since then on banking sector stabilization, restructuring, and consolidation. The regulatory and supervisory framework has been strengthened in a way consistent with an increasingly market-oriented, globalized environment. As a result, the worst is over in the Japanese banking system, setting the stage for sustained economic recovery. Though bank capital may still be inadequate, safety nets are in place, the credit allocation has been made more rational. Remaining risks are limited to regional and smaller institutions that are vulnerable to weak, local economic conditions and hikes of the long-term interest rate.Asset price bubble, Japan's "lost decade", systemic banking sector crisis, bank restructuring and consolidation, market-based regulatory and supervisory framework

Implications of the currency crisis for exchange rate arrangements in emerging East Asia

The authors examine the implications of the East Asian currency crisis for exchange rate arrangements in the region's emerging market economies. They focus on the roles of the U.S. dollar, the Japanese yen, and the euro in the emerging East Asian economies'exchange rate policies. They claim that these economies are particularly susceptible to large exchange rate fluctuations because they have been pursuing financial deregulation, opening markets, and liberalizing capital accounts, and becausethey face increased risk of sudden capital flow reversals, with attendant instability in their financial system and foreign exchange market. The authors find that the dollar's role as the dominant anchor currency in East Asia was reduced during the recent currency crisis but has become prominent again since late 1998. It is too early for conclusions, but the economies seem likely to maintain more flexible exchange rate arrangements, at least officially. At the same time, these economies presumably will continue to prefer to maintain exchange rate stability without fixed rate commitments. They are better off choosing a balanced currency basket system in which the yen and the euro play a more important role than before. The ASEAN countries have a special incentive to avoid harmful fluctuations in exchange rates within the region, which could suddenly alter their international price competitiveness and make prospective free trade agreements unsuitable. So they may stabilize their exchange rates against similar currency baskets, to ensure intraregional exchange rate stability.Economic Stabilization,Economic Theory&Research,Foreign Trade Promotion and Regulation,Fiscal&Monetary Policy,Macroeconomic Management

Proposed strategy for a regional exchange rate arrangement in post-crisis East Asia

After discussing major conceptual, and empirical issues relevant to the exchange rate policies of East Asian countries, the authors propose a regional exchange rate arrangement designed to promote intra-regional exchange rate stability, and regional economic growth. They argue that: 1) For developing countries, exchange rate volatility tends to significantly hurt trade and investment, making it inadvisable to adopt a system of freely floating exchange rates. 2) Given the high share of intra-regional trade, and the similarity of trade composition in East Asia, exchange rate policy should be directed toward maintaining intra-regional exchange rate stability, to promote trade, investment, and economic growth. 3) the current policy of maintaining exchange rate stability against U.S. dollar as an informal, uncoordinated mechanisms for ensuring intra-regional exchange rate stability is sub-optimal. A pragmatic policy option - conducive to a more robust framework for cooperation in monetary, and exchange rate policy - wold be a coordinated action to shift the target of nominal exchange rate stability, to a basket of tri-polar currencies (the U.S. dollar, the Japanese yen, and the Euro). This alternative would better reflect the region's diverse structure of trade, and foreign direct investment.The authors envision no rigid peg. Instead, at least initially, each country could choose its own formal exchange rate arrangement - be it currency board, a crawling peg, or a basket peg with wide margins. At times of crisis, the peg might be temporarily suspended, subject to the rule that the exchange rate would be restored to the original level as soon as practical. Only in extreme circumstances, would the level be adjusted to reflect new equilibrium conditions.Environmental Economics&Policies,Economic Stabilization,Macroeconomic Management,Fiscal&Monetary Policy,Economic Theory&Research

Regulating Systemic Risk

The failure to spot emerging systemic risk and prevent the current global financial crisis warrants a reexamination of the approach taken so far to crisis prevention. The paper argues that financial crises can be prevented, as they build up over time due to policy mistakes and eventually erupt in slow motion. While one cannot predict the precise timing of crises, one can avert them by identifying and dealing with sources of instability. For this purpose, policymakers need to strengthen top-down macroprudential supervision, complemented by bottom-up microprudential supervision. The paper explores such a strategy and the institutional setting required to implement it at the national level. Given that the recent regulatory reforms that have been undertaken to address systemic risks are inadequate to prevent and combat future crises, the paper argues that national measures to promote financial stability are crucial and that the Westphalian principles governing international financial oversight should be rejected. The paper proposes that while an effective national systemic regulator should be established, strong international cooperation is indispensable for financial stability.systemic risk, global financial crisis, macroprudential supervision, microprudential supervision, regulatory reform

Japan's official development assistance : recent issues and future directions

Japan remains the world's largest national donor of aid funds. But the Japanese government, facing prolonged economic stagnation and mounting public sector debt, is under increasing public pressure to reduce aid budgets and to use official development assistance in more explicit pursuit of Japan's own economic and political interests. Internationally, Japan continues to attract criticism for its emphasis on infrastructure projects and its limited willingness to participate in multilateral partnerships. The authors argue that Japan can meet these domestic and international challenges by developing a coherent national strategy for official development assistance, broadly designed to enhance effectiveness, accountability, and transparency.Decentralization,Banks&Banking Reform,Payment Systems&Infrastructure,Gender and Development,Economic Adjustment and Lending,Banks&Banking Reform,Development Economics&Aid Effectiveness,Economic Theory&Research,Economic Adjustment and Lending,Public Sector Economics&Finance

Regulating Systemic Risk

The failure to spot emerging systemic risk and prevent the current global financial crisis warrants a reexamination of the approach taken so far to crisis prevention. The paper argues that financial crises can be prevented, as they build up over time due to policy mistakes and eventually erupt in "slow motion." While one cannot predict the precise timing of crises, one can avert them by identifying and dealing with sources of instability. For this purpose, policymakers need to strengthen top-down macroprudential supervision, complemented by bottom-up microprudential supervision. The paper explores such a strategy and the institutional setting required to implement it at the national level. Given that the recent regulatory reforms that have been undertaken to address systemic risks are inadequate to prevent and combat future crises, the paper argues that national measures to promote financial stability are crucial and that the Westphalian principles governing international financial oversight should be rejected. The paper proposes that while an effective national systemic regulator should be established, strong international cooperation is indispensable for financial stability.global financial crisis; systemic risk; macroprudential supervision; systemic stability regulation; regulating systemic risk

Asia's Post-Global Financial Crisis Adjustment: A Model-Based Dynamic Scenario Analysis

Using a dynamic global general equilibrium model, the paper assesses the short- and medium-term impacts of the global financial crisis on Asian economies and the implications of post-crisis adjustment in emerging East Asia (EEA) for the world economy. The analysis suggests that EEA is unlikely to be severely damaged permanently by the global financial crisis, and a worldwide fiscal stimulus could play an important role in stabilizing the global economy in crisis. EEA’s efforts at strengthening regional demand, in conjunction with adopting a more flexible exchange rate regime, will promote more balanced regional growth and facilitate an orderly global rebalancing. However, despite the growing size of EEA in the global economy, the region’s growth rebalancing has only modest spillover effects on the rest of the world. EEA can contribute to global growth, but it alone cannot become the sole engine driving post-crisis growth in the world economy.Computable general equilibrium model; global financial crisis; Easst Asia; emerging

Regionalism as an Engine of Multilateralism: A Case for a Single East Asian FTA

As East Asia becomes increasingly integrated through market-driven trade and FDI activities, free trade agreements (FTAs) are proliferating. Consolidation of multiple and overlapping FTAs into a single East Asian FTA can help mitigate the harmful noodle bowl effects of different or competing tariffs, standards, and rules. A region-wide FTA will also encourage participation of low-income countries and reduce trade-related business costs, particularly for small and medium enterprises. A computable general equilibrium (CGE) model examines the economic impact of various types of FTAs in East Asia (among ASEAN+1's, ASEAN+3, and ASEAN+6) finding that consolidation at the ASEAN+6 level would yield the largest gains to East Asia among plausible regional trade arrangements.Free Trade Agreement; ASEAN; multilateralism