Exchange Rates in the East Asian Crisis

Abstract

This paper looks at the recent history of East Asian exchange rate regimes in the context of the wider international discussion of exchange rates. It examines whether the exchange rate regimes were a cause of the crisis, or whether the crisis would have emerged under alternative exchange rate regimes. It focuses on the relationship between the exchange rate regime and the recovery process. It then asks whether exchange controls can help in maintenance of exchange rate and economic stability. The article concludes with a discussion of how the recent experience may affect future choice of exchange rate regimes. The sense of crisis in East Asia in the third quarter of 1997 was generated by the successive collapse of several Southeast Asian currencies, followed by the Korean won in the fourth quarter. The problems were later felt more generally as a financial and an economic crisis. There is a consensus amongst economists and policy makers that the exchange rate regimes that were applied in Southeast Asia and Korea immediately prior to the crisis were flawed, and contributed substantially to the catastrophic decline in economic output in the year or so from mid-1997. There is as yet no consensus on the exchange rate regimes that are most suited to the restoration of sustained growth through East Asia. By the mid-1990s, most East Asian economies had settled into de facto pegging of their currencies against the U.S. dollar. The pegs were articulated with varying degrees of commitment by the monetary authorities and sometimes but not always were accompanied by deliberately complementary domestic demand policies. A few of the pegs were supported by intrusive exchange controls. The main exception to the de facto peg was Japan, which had floated the yen ever since the breakdown of the Bretton Woods system of firmly fixed (but adjustable) exchange rates in the early 1970s. All currencies in the region had been through periods of floating rates or major changes of parity over the preceding two decades, before sliding into a de facto peg against the U.S. dollar. The shift to the de facto peg had occurred early in Hong Kong (in 1983, after a period of great volatility of a floating rate), and was most recent for Taiwan. The de facto pegs were mostly blown apart by the crisis, and succeeded by floating currencies. The floating rates were widely seen as being temporary, but the monetary authorities so far have had little to say about their likely longevity, or about the regimes that are likely to succeed them. The exceptions to the shift to floating rates are Hong Kong and China, which have staunchly and so far successfully defended the 1997 parities against the U.S. dollar; Vietnam, which has devalued its currency but moved to a lower, fixed rate; and Malaysia, which returned to a fixed parity, at a lower rate, in the third quarter of 1998, after a little over a year of major depreciation within a floating rate. This article looks at the recent history of East Asian exchange rate regimes in the context of the wider international discussion of exchange rates. It examines whether the exchange rate regimes were a cause of crisis, or whether the crisis would have emerged under alternative exchange rate regimes. It focuses on the relationship between the exchange rate regime and the recovery process. It then asks whether exchange controls can help in maintenance of exchange rate and economic stability. The article concludes with discussion of how the recent experience may affect future choice of exchange rate regimes. Exchange Rates: Evolving Regimes in International Perspective Most East Asian economies were members of the global system of fixed exchange rates until the collapse of the Bretton Woods system in the early 1970s. Some were comfortable members, while others had great difficulty in reconciling a fixed exchange rate against major world currencies with its implications for domestic demand management. …