The Return to Soft Dollar Pegging in East Asia: Mitigating Conflicted Virtue

Abstract

Before the 1997–98 crisis, the East Asian economies – except for Japan – informally pegged their currencies to the dollar. These soft pegs made them vulnerable to a depreciating yen, thereby aggravating the crisis. To limit future misalignments, the IMF wants East Asian currencies to float freely. Alternatively, authors have proposed increasing the weight of the yen in East Asian currency baskets. However, dollar pegs are entirely rational from the perspective of each Asian country – both to facilitate hedging by merchants and banks against exchange risk, and to help central banks anchor their domestic price levels. Post‐crisis, as the East Asian economies transform themselves from being dollar debtors into dollar creditors, they face ‘conflicted virtue’: pressure to appreciate their currencies that could lead to a deflationary spiral. Rather than undervaluing their currencies to promote exports as is commonly alleged, East Asian governments are trapped into returning to – and then maintaining – soft dollar pegs.

Is East Asia as Prepared as Eurozone for Monetary Union?

“…In Asia, the variability levels of the real rates with US are the smallest. This seems to be consistent with the return to the dollar standard in East Asia after the Asian crisis (see McKinnon, Schnabl 2004). Though the volatility levels with Japan are high, they are highly homogenous across countries.…”

“…In particular, due to political difficulties, integration might be relatively easier if the exchange rates are jointly fixed to an anchor at the initial stage of integration as many of the countries have experiences in pegging or fixing their exchange rates (mostly to the dollar, see e.g. McKinnon, Schnabl 2004) in the past.…”

Monetary Policy Reform in a World of Central Banks

“…Given more flexible exchange rate regimes, the threat of inflation and asset price bubbles, sterilization costs (which erode central bank independence) or revaluation losses on foreign currency denominated assets provide an inherent incentive to intervene against appreciation pressure on domestic currencies (Löffler, Schnabl and Schobert 2011). 6 McKinnon and Schnabl (2004) Although the institutional framework of the European Central Bank is modeled in the German spirit to protect the wealth of savers based on a stability oriented monetary policy, decision making in the ECB is based on the one-country-one-vote principle. This gives a substantial weight to former weak currency and current intraEuropean debtor countries.…”

Can the Traditional Asian Us Dollar Peg Exchange Rate Regime Be Extended to Include the Japanese Yen?

“…Most regional monetary authorities have traditionally managed their exchange rates relative to the US dollar (see Frankel and Wei (1994), McKinnon (2000McKinnon ( , 2004 and Kearney andMuckley (2006a, 2006b)). This exchange rate setting practice was motivated by the possibility of achieving price stability alongside the goals of regional financial market and trade integration and the desire to avoid penalising resident investors exposed to foreign exchange rate risk.…”