Recommending a Currency Basket System for Emerging East Asia

Abstract

This chapter examines exchange rate arrangements in East Asia’s emerging market economies since the 1990s and proposes a more desirable regime for the region in the immediate future. It focuses on the role of the US dollar, the Japanese yen, and the euro as anchor currencies in the exchange rate policies of these economies. The chapter claims that the dollar’s role as the dominant anchor for exchange rate stabilization in crisis-affected East Asia was reduced due to a general shift to more flexible exchange rate arrangements during the recent currency crisis but has become prominent again, with greater importance of the Japanese yen, since 1999. These economies are likely to maintain exchange rate flexibility, at least officially. At the same time, the economies will continue to prefer stable exchange rates without fixed rate commitments. Given the high volatility of yen/dollar exchange rates and partner diversity of trade and FDI relationships, the economies would be better off stabilizing their currencies to a balanced currency basket in which the yen and the euro play more important roles than previously. Emerging East Asia should manage their currencies to maintain relatively stable real effective exchange rates. Economies that are currently under a US dollar peg, Malaysia, China, and Hong Kong, need to exit to a currency basket system before the next round of exchange market pressure develops. The proposed currency basket system needs to be supported by regional surveillance and financing mechanisms. With greater political and institutional developments, a more robust framework of macroeconomic and exchange rate cooperation is expected to evolve in the region.