A tale of Asian exchange rate management: Romance of the three currencies

Abstract

Asian currencies lack regional policy coordination and are therefore subject to volatilities such as the Asian currency crisis of 1997/99. As the Asian currencies have already been observed to be 'flying-in-unison', a stable exchange rate arrangement can be helpful as the next step of evolution for regional financial stability. We consider that creating a cluster effect from coordinated efforts/policies of policy-makers can lead to regional exchange rate stability. To demonstrate this cluster effect, a three-party-game is computed for an Asian bloc, viz-á-viz US dollar and the Euro, based on a Nash and a cooperative equilibrium. The cluster effect would generate external and internal pressures that work towards the formation of a regional currency, although the exact form of exchange rate regime would have to await political consensus. There are substantial welfare gains within Asia network economy through currency cooperation. The formation of an Asian currency bloc would also create counter-balance to the current dominance of the US dollar and the Euro. Like the epic story of Three Kingdoms who sought hegemony in Chinese history, the Asian currency bloc will contend with many possible outcomes of competition as well as cooperation.Exchange rate arrangement Flying-in-unison Cluster effect Policy cooperation