Korea, and Hong Kong. The empirical analysis estimates coefficients placed on the three major currencies (the US dollar, the Japanese yen, and the euro) for ...
Regional Financial Cooperation and Monetary Integration in East Asia*
March, 2006
Eiji Ogawa, Hitotsubashi University
*
The author is grateful for Dr. Pakorn Vichyanond (TDRI) and other participants at the
international conference of the Economic and Social Research Institute of the Cabinet Office on January 23, 2006.
Summary In this paper, we overviewed the current financial and monetary cooperation (the Chiang Mai Initiative) in East Asia. The Chiang Mai Initiative includes a currency swap arrangements for a currency crisis management and a surveillance process for a currency crisis prevention. After we overviewed the current Chiang Mai Initiative, we proposed further developments of the Chiang Mai Initiative. Moreover, we discussed a desirable exchange rate system for East Asian countries. It is proved that a currency basket system is desirable for East Asian countries after we take into account a fact that East Asian economies have strong economic relationships with intra-regional countries, the United States, and European countries. We investigated actual exchange rate systems that are adopted by the monetary authorities of East Asian countries. We focused on the Chinese exchange rate system reform that was announced on July 21, 2005. The Chinese government announced to shift from dollar peg system to a managed floating exchange rate system with reference to a currency basket. However, our empirical analysis showed that the Chinese monetary authority has little changed its exchange rate policies in terms of targeting the US dollar. We pointed out unsustainability of the US current account deficits and possibilities of depreciating US dollar. Also, we pointed out that East Asian currencies will have asymmetric reaction to the deflationary US dollar under the current variety of exchange rate systems of East Asian currencies. The situation is called as “coordination failure” in choosing a desirable exchange rate system. We pointed out necessity of making policy coordination to solve the coordination failure. We proposed a regional monetary cooperation in East Asia, which includes strengthening the surveillance process and introducing a regional common unit of account, that is called as Asian Monetary Unit (AMU). We explain details of AMU and AMU Deviation Indicators. A combination of both stabilizing value of the AMU in terms of a currency basket of the US dollar and the euro and decreasing of AMU Deviation Indicator of each of East Asian currencies make the relevant East Asian currency stabilize but both intra-regional exchange rates and the AMU in terms of a currency basket of the US dollar and the euro. We propose a multi-step approach toward a common currency in East Asia. The multi-step approach should be taken in terms of both “deepening and widening.”
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1. Introduction The Asian currency crisis in 1997 that East Asian countries experienced is the largest motivation to go toward a regional financial and monetary cooperation and even a regional monetary integration in East Asia. It is often said that any political initiatives are needed to move toward a monetary integration. However, the shared currency crisis experience among East Asian countries might be a driving force for a regional monetary integration in this region. This paper overviews the current regional financial and monetary cooperation and the current situation of exchange rate systems and exchange rate policies in East Asia. After we identify the current situation in East Asia, this paper consider a desirable regional monetary cooperation in East Asia which include strengthening the surveillance process of ASEAN+3 Finance Ministers’ Meetings by introducing an Asian Monetary Unit (AMU) and AMU Deviation Indicators of each of East Asian countries. Lastly, this paper proposes a multi-step approach toward a common currency in East Asia. At the next section, we overviews the current financial and monetary cooperation in East Asia, that is represented by the Chiang Mai Initiative. The Chiang Mai Initiative includes a currency swap arrangements for a currency crisis management and a surveillance process for a currency crisis prevention. After we overview the current Chiang Mai Initiative further developments of the Chiang Mai Initiative are proposed. At the third section, we discuss a desirable exchange rate system for East Asian countries. It is proved that a currency basket system is desirable for East Asian countries after we take into account a fact that East Asian economies have strong economic relationships with intra-regional countries, the United States, and European countries. At the fourth section, we investigate actual exchange rate systems that are adopted by the monetary authorities of East Asian countries. We focus on the Chinese exchange rate system reform that was announced on July 21, 2005. At the fifth section, the Chinese government announced to shift from the current dollar peg system to a managed floating managed floating exchange rate system with reference to a currency basket. However, our empirical analysis shows that the Chinese monetary authority has little changed its exchange rate policies in terms of targeting the US dollar. At the sixth section, we point out unsustainability of the US current account deficits and possibilities of depreciating US dollar. Also, we point out that East Asian currencies will have asymmetric reaction to the deflationary US dollar under the current variety of exchange rate systems of East Asian currencies. The situation is called as “coordination failure” in choosing a desirable exchange rate system. At the
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seventh section, we point out necessity of making policy coordination to solve the coordination failure. We propose a regional monetary cooperation in East Asia, which includes strengthening the surveillance process and introducing a regional common unit of account that we call as Asian Monetary Unit (AMU). At the eighth section, we explain details of AMU and AMU Deviation Indicators. A combination of both stabilizing value of the AMU in terms of a currency basket of the US dollar and the euro and decreasing of AMU Deviation Indicator of each of East Asian currencies make the relevant East Asian currency stabilize but both intra-regional exchange rates and the AMU in terms of a currency basket of the US dollar and the euro. At the ninth section, we propose a multi-step approach toward a common currency in East Asia. The multi-step approach should be taken in terms of both “deepening and widening.” At last section, we refer conclusion from these investigation.
2. The Chiang Mai Initiative and its Future Developments The Chiang Mai Initiative is a regional financial cooperation and monetary coordination that was agreed among ASEAN, Japan, China, and Korea (ASEAN+31) at the Finance Ministers’ Meeting of ASEAN+3 in Chiang Mai, Thailand in 2000. The Chiang Mai Initiative has established a network of bilateral currency swap arrangements among ASEAN+3 countries as shown in Figure 1. The currency swap arrangements amounts US$ 58.5 billion as of November 2005. Under the Chiang Mai Initiative, bilateral currency swap would be conducted between a crisis-hit country and the other members after it faced a currency crisis. In this sense, the currency swap managements are just to manage currency crises. They have no function of preventing them. Measurements of strengthening the Chiang Mai Initiative were agreed to enter the second stage at the ASEAN+3 Finance Ministers’ Meeting held in Istanbul on May 4, 2005. The first is to strengthen regional economic surveillance that is called as “Economic Review and Policy Dialogue (ERPD), by incorporating it into a framework of the Chiang Mai Initiative. Especially, outside researchers’ resources are used in order to strengthen effective regional surveillance capacity. The second is to establish collective decision-making mechanism as the first step for changing the existing bilateral swap arrangements into a multilateral
ASEAN+3 includes The ASEAN+3 is composed of Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, the Philippines, Singapore, Thailand, Vietnam, Japan, South Korea, and China.
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agreement. So far exercises of the currency swap arrangement have been made by an individual request and individual decision-makings under the bilateral arrangement. Exercises of the currency swap arrangement will be made by a request and a collective decision –making by choosing in advance a coordinator country in future. Introduction of a collective decision-making mechanism is regarded as the first important step as a process toward a multilateral arrangements. But the collective decision-making mechanism sometimes has higher possibilities of impeding mobility than the individual decision-making. It is considered to introduce a majority decision rule and to make individual decisions of present bilateral swaps in the case when the collective decision is not made within a definite period of time in order to solve the problems.
Figure 1: Network of Bilateral Swap Arrangements under the Chiang Mai Initiative http://www.mof.go.jp/jouhou/kokkin/frame.html The Chiang Mai Initiative has an objective to establish a regional financial cooperation that is complementary to existing international institutions such as the International Monetary Fund (IMF) in order to strengthen self-helping and supporting mechanism through a ASEAN+3 framework. For the purpose, the Chiang Mai Initiative is to strengthen existing framework among the monetary authorities of ASEAN+3. On one hand, the currency swap arrangements are a financial cooperation that a counterpart of the arrangement finance international reserves to a country that face in a currency crisis according to the arrangements. For the reason, the currency swap arrangements based on the Chiang Mai Initiative have a function as currency crisis management in the sense of giving a financial support after the currency crisis occurred.
The third is to increase size of the currency swap arrangements. It is to double the existing arrangements, to conclude new arrangements, and to change unilateral agreements to bilateral agreements. Moreover, the fourth is to raise the ceiling of currency swap that will be able to exercise independently with IMF program from 10% to 20% in order to cope with sudden market turmoil flexibly. The Chiang Mai Initiative based currency swap arrangements are built up as a
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network of bilateral currency swap arrangements as shown in Figure 1. Equalization and harmonization of conditionality among the component bilateral currency swap arrangements are necessary in order that the network of bilateral currency swap arrangements should work quickly and efficiently for currency crisis management. It was clarified that the monetary authorities of ASEAN+3 countries are going for multilateralization of currency swap arrangements at the ASEAN+3 Finance Ministers’ Meeting that was held in Istanbul on May 4, 2005. It implies that they have begun to move forward harmonization of currency swap arrangements. However, the collective decision-making mechanism has possibilities of impeding its maneuverability at the stages in progress toward multilaterization. For the reason, it is necessary to go toward a multilateral currency swap arrangements further. Also, a regional economic surveillance will be integrated into a framework of the Chiang Mai Initiative for its strengthening according to conclusion at the Meeting in Istanbul. It is desirable to strengthen the Chiang Mai Initiative at an aspect of regional surveillance in order that it should work not only for currency crisis management but also for currency crisis prevention. For the purpose, the monetary authorities should not only conduct prompt currency crisis managements but also strengthen surveillance that contributes to prevention of currency crisis. The surveillance should increase incentives of governments to keep a good economic performance. The IMF established a Contingent Credit Line (CCL) in order to prevent a currency crisis that is caused by liquidity shortage in 1999. It is to give the Contingent Credit Line for limited countries that have good economic performance at the ex-ante screening in the case where the country does not worsening its economic fundamentals but fall in a foreign reserves due to a temporary liquidity surveillance. The CCL gives quick financial support to the currency crisis countries because they can receive promptly emergence loan. The CCL was abolished in 2003 at the Band because no governments apply for the CCL. It is too expensive commitment fees why no governments applied for the CCL. Moreover, governments worried about possibilities that they received a bad result of ex-ante screening from the IMF when they applied it. The result may give a signal of band economic performance to investors and decrease credibility of domestic economy. We have to overcome the reasons of abolishing the CCL of the IMF. For the purposes, it is necessary to decrease the commitment fees as long as it does not cause government moral hazard. There are possibilities that a currency crisis occurs by speculative attacks against a currency even though its economic fundamentals do not worsen. The currency
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crisis is self-fulfilling. It is said that the ERM crisis occurred in 1992 is one of the self-fulfilling currency crisis. A plentiful foreign reserve is necessary in order to prevent such a self-fulfilling crisis by speculative attacks. For the purpose, it is effective for governments to pool foreign reserves or to give earmark to foreign reserves among the regional countries. The pooling of foreign reserves is to give substances to the current currency swap arrangements.
3. Desirable Exchange Rate System for East Asian Countries East Asian countries have characteristics of having strong economic relationships with a variety of countries that include intra-regional countries, the United States, and European countries. East Asian countries have been establishing a production network by strengthening economic relationships in terms of international trade and foreign direct investments. Moreover, financial capital is relatively free to move among the countries though regulations on cross-boarder capital and foreign exchange transactions are kept in force in some of the counties. It is suggested that the monetary authorities of the countries should adopt a currency basket system under the strong economic relationships with a variety of countries (Ogawa, Ito, and Sasaki (2004)). The currency basket system may include a currency basket peg system and a managed floating exchange rate system with reference to a currency basket. The latter is one that the Chinese government announced to adopt on July 21, 2005. The most apparent benefit of a basket currency system is its role in keeping trade competitiveness relatively stable. If the export destination is only one country and there is no competitor other than the destination country, it is enough to peg the currency to that of the export destination country as to maintain trade competitiveness. But actually, a country tends to have many export destinations and many competitors all over the world. In addition, the composition of export destination countries has changed over time. Thus it is not easy to decide the weights of the basket. Taking into account this complexity, some papers suggest the ways to get optimal weights for the currency basket. Ito, Ogawa, and Sasaki (1998) calculated the optimal weights that stabilize variances of trade balance. In one paper (Ito, Ogawa, and Sasaki (1998), we built a theoretical model in which the Asian firm maximizes its profits, competing with the Japanese and the US firms in their markets. We used a duopoly model to determine export prices and volumes in response to fluctuations of the exchange rate vis-à-vis the Japanese yen and the US dollar. We obtained optimal basket weights that would minimize the fluctuation of the growth rate of the trade balance.
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Ito, Ogawa, and Sasaki (1998) stressed the fact that Asian countries’ adoption of de facto dollar peg regimes, although their trade weight with Japan was substantial, was one of the most significant factors that induced the crisis. As the Japanese yen depreciated against the US dollar from April 1995 to the summer of 1997, the real effective exchange rates of Asian countries appreciated, causing the countries to lose export competitiveness. Thus exports from those countries declined. For example, the gross export values of Thailand did not grow in 1996, compared with 20% growth a year earlier. The optimal weights proposed by Ito, Ogawa, and Sasaki (1998) are shown in Table 1. They estimated weights from actual fluctuations of the exchange rates are quoted from Frankel and Wei (1994). The optimal weights of the yen are higher than the estimated weights. It suggests that, if Asian currencies peg to a currency basket with the optimal weights, the real effective exchange rates of Asian countries would be more stable and a large shock to trade balance can be avoided.
Table 1: Optimal Weight for a Currency Basket for East Asian Countries Currency
Actual weight $(%)
Yen (%)
Optimal weight $(%)
Yen (%)
Thai Baht
91
5
35.3
64.7
Indonesian Rupiah
95
16
77.9
22.1
Korean Won
96
-10
45.7
54.3
Taiwan Dollar
96
5
7.3
92.7
Singaporean Dollar
75
13
51.0
49.0
Philippine Peso
107
-1
72.8
27.2
Sources: Ogawa, Ito, and Sasaki (2004), Frankel and Wei (1994) and Ito, Ogawa, and Sasaki (1998). Actual weights were estimated from actual movements of the exchange rates. Asian currencies (in terms of the Swiss franc) were regressed on the U.S. dollar (in terms of the Swiss franc) and Japanese yen (in terms of the Swiss franc). Optimal weights were derived to minimize fluctuation of the growth rate of trade balance.
While Ito, Ogawa, and Sasaki (1998) emphasized the trade aspect, exchange rates are likely to be influenced by capital flows. Ogawa and Sun (2001) analyzed how the de facto dollar peg regime before 1997 had influenced capital inflows to Indonesia, Korea, and Thailand—the three countries that will need International Monetary Fund (IMF) financial support later. They conducted a simulation analysis of a counterfactual
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hypothesis that the monetary authorities had adopted a currency basket peg system instead of the de facto dollar peg system. They assumed that the foreign exchange risks of the home currency against the US dollar would be doubled while foreign exchange risks of the home currency against the yen would be halved under the currency basket peg system. The regression analysis of the actual capital inflows found that the responsiveness of capital flows to the foreign exchange risk against the US dollar is much larger than the responsiveness of capital flows to the foreign exchange risk against the yen in the case of Korea and Thailand. The simulation analysis by Ogawa and Sun (2001) found that the currency basket peg system would have had a depressing effect on capital inflows to Korea and Thailand. Sasaki (2002) analyzed whether changes in capital inflows to East Asian countries (Korea, Malaysia, Philippines, Singapore, and Thailand) could be explained by the variance of exchange rates. The results showed that capital inflows to East Asian countries increased when the variance of US dollar rates (i.e., exchange rates risk of the US dollar) decreased. Thus, the de facto dollar peg induced more capital inflows than did under the currency basket or the floating exchange rates regime. Both Ogawa and Sun (2001) and Sasaki (2002) concluded that the de facto dollar peg regime promoted capital inflows to Asian countries and implied that if Asian countries had adopted a basket currency regime (or the floating exchange rate regime), capital inflows might not have been so huge. These two papers do not examine whether huge capital inflows due to de facto dollar peg was good or bad for the economies of those countries in the long run. Capital inflow itself promotes growth and may be good for an emerging country. But huge capital inflows also pose a risk to the countries in the sense that a sudden reversal in the direction of capital flows is a possibility. In fact, the outflow of short-term capital experienced by some of the countries in the region before the crisis was damaging to the firms in Asian countries. FDI (long-term capital), as opposed to bank liabilities (short-term capital), are not likely to be subject to short-term exchange rate risks. Sasaki (2002) analyzed capital inflows separately by type: portfolio investments, bank lending, and FDI. The effect of the variance of the US dollar on capital inflows was the strongest in bank liabilities and was not so large in portfolio investments and FDI. It means that if Asian countries had adopted a basket currency regime, bank liabilities would have decreased but portfolio investments and foreign direct investments would not have been affected so much. Thus, moderating capital inflows is thought to be a benefit of a basket currency regime.
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4. Exchange Rate Policies in East Asian Countries At first, we should look at the IMF’s classification for exchange rate systems in East Asian countries because movements in exchange rates depend on what kind of exchange rate system the monetary authorities are adopting. According to the IMF’s classification in 2003, Japan, Korea, and the Philippines are adopting a floating exchange rate system. Indonesia, Singapore, Thailand, Cambodia, Myanmar, Lao, and Vietnam are adopting a managed floating exchange rate system. It is China and Malaysia that are adopting a fixed exchange rate system, especially pegging their home currencies to the US dollar. Hong Kong and Brunei are adopting a currency board system. Hong Kong is pegging its home currency to the US dollar while Brunei is pegging its home currency to the Singapore dollar. Thus, we can classify the East Asian countries’ exchange rate systems into three groups; a floating group, a managed floating group, and a fixed (dollar pegging) group. The adopted exchange rate system might determine degree of linkages of each of the currencies with the US dollar. Next, an empirical analysis is conducted to investigate how much degree of linkages each of the East Asian currencies actually have with the US dollar. For the purpose, the empirical analytical method of Frankel and Wei (1994) is to analyze the linkages of some of the East Asian currencies to the US dollar.2 It is covered the ASEAN5 countries (Thailand, Malaysia, Singapore, Indonesia, the Philippines), China, Korea, and Hong Kong. The empirical analysis estimates coefficients placed on the three major currencies (the US dollar, the Japanese yen, and the euro) for each of the East Asian currencies. According to Frankel and Wei (1994), it is supposed that the Swiss franc as a numare in denomination of exchange rates. Daily data of exchange rates are used to regress to log differences of a local currency (in terms of the Swiss franc) on log differences of the three major currencies (in terms of the Swiss franc) for each quarter of the sample period from 1999 to 2003. The regression for each quarter of the sample period from 1999 to 2003 is to investigate dynamics of coefficients on the three major currencies during the period.3 The regression equation is the following one:
Kawai and Akiyama (1998, 2000) conducted the method to investigate exchange rate policy of East Asian countries. 3 McKinnon (2002) and Ogawa (2002a) conducted the similar method to investigate the dynamics of the coefficients. 2
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Δ log e home / SFR = a0 + a1Δ log eUSD / SFR + a2 Δ log e JPY / SFR + a3Δ log eeuro / SFR + ε t
where e
home / SFR
: exchange rate of a home currency in terms of the Swiss franc, e
USD / SFR
exchange rate of the US dollar a home currency in terms of the Swiss franc, e exchange rate of the Japanese yen in terms of the Swiss franc, e
euro / SFR
JPY / SFR
: :
: exchange rate
of the euro in terms of the Swiss franc. Results of the regression for each of the East Asian currencies proved that coefficients on the US dollar are nearly equal to a unity for all of the East Asian countries over time. On one hand, coefficients on the Japanese yen and the euro are very small and statistically insignificant in many cases though we found several significant coefficients on the Japanese yen in the case of the Singapore dollar, and the Korean won. Figures 2.1 to 2.8 focus on the coefficient on the US dollar to summarize the regression results. A solid line in the figures represents estimates of the coefficients for each quarter of the sample period. Broken lines represent estimates plus or minus 2 times standard deviations of the coefficients. A band between the two broken lines means a confidential interval at about 95%. Figure 2.1 shows movements of the coefficient on the US dollar for the Thai baht. The coefficients were nearly equal to a unity although they have decreased from a unity since the 4th quarter of 2002. Figure 2.2 shows movements of coefficients on the US dollar for the Singapore dollar. The coefficients are about 0.8 from 1999 to 2001 although they are not significantly equal to a unity almost during the period. The coefficients on the US dollar have decreased from since the 2nd quarter of 2002. Figure 2.3 shows movements of coefficients on the US dollar for the Korean won. The coefficients on the US dollar are nearly equal to a unity in 1999 and 2000. After that they have decreased and significantly different from a unity for some of the periods. The three figures show that the Thai baht, the Singapore dollar, and the Korean won have the similar characteristics for the coefficients on the US dollar during the sample period.
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Figure 2.1: Weights on the US dollar for the Thai baht
Figure 2.2: Weights on the US dollar for the Singapore dollar
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Figure 2.3: Weights on the US dollar for the Korean won
Figure 2.4: Weights on the US dollar for the Philippine peso
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Figure 2.5: Weights on the US dollar for the Indonesia rupiah
Figure 2.6: Weights on the US dollar for the Malaysian ringgit
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Figure 2.7: Weights on the US dollar for the Hong Kong dollar
Figure 2.8: Weights on the US dollar for the Chinese yuan
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Figure 2.4 shows movements of coefficients on the US dollar for the Philippine peso. The coefficients have kept a similar level during a sample period from 1999 to 2003. Figure 2.5 shows movements of coefficients on the US dollar for the Indonesia rupiah. The coefficients have kept a similar level during a sample period from 1999 to 2003 while the standard deviations have decreased. The decreases in the standard errors imply that the Indonesia rupiah has more stable linkages with the US dollar in recent years. Figure 2.6 shows movements of coefficients on the US dollar for the Malaysian ringgit. The Malaysian ringgit has been formally pegging to the US dollar under the fixed exchange rate system. The coefficients on the US dollar always equal to a unity during the sample period. It is characteristic that the standard errors of the coefficient are very small. Figure 2.7 shows movements of coefficients on the US dollar for the Hong Kong dollar. The Hong Kong dollar also has been formally pegging to the US dollar under the currency board system. The coefficients on the US dollar always equal to a unity during the sample period while the standard errors of the coefficient are very small. Figure 2.8 shows movements of coefficients on the US dollar for the Chinese yuan. The Chinese yuan has the same characteristics for the coefficient on the US dollar as the Malaysian ringgit and the Hong Kong dollar. The coefficients on the US dollar always equal to a unity during the sample period while the standard errors of the coefficient are very small. The last three figures shows that the Malaysian ringgit, the Hong Kong dollar, and the Chinese yuan has the same characteristics for the coefficients on the US dollar
5. The Chinese Exchange Rate System Reform and its reality The Chinese government has changed its exchange rate system from the dollar peg system into a managed floating exchange rate system “with reference to” a currency basket on July 21, 20054. The exchange rate system reform has been regarded as a historical regime switching in China. This Chinese government decision has preferable effects on neighboring countries in choosing exchange rate system or exchange rate policy because the monetary authorities face coordination failure in choosing their exchange rate policies (Ogawa and Ito (2002), Ogawa (2002)). The evidence is that the The Chinese government has adopted a managed floating exchange rate system not only “with reference to” a currency basket but also with a band (plus and minus 0.3% around the base rate). It could adjust the exchange rate by crawling the base rate. It would be a kind of BBC rule (Williamson (2000)). 4
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Malaysian government has changed its exchange rate system from the dollar peg system into a currency basket system on the same day when the Chinese government did so. Solving the coordination failure might prevent misalignments among East Asian currencies and, in turn, lead to a coordination of exchange rate policies in the future (Ogawa (2004)). Ogawa and Sakane (2006) investigate how the Chinese government has been conducting its actual exchange rate policy under the managed floating exchange rate system “with reference to” a currency basket after it announced its changing exchange rate policy to a currency basket system. We use the Kalman filter method to conduct the estimation of coefficients on the US dollar and the other three currencies5. The Kalman filter method is used to estimate time-varying coefficients. The regression equation is the following one:
Δ log e RMB / SFR = a0 + a1Δ log eUSD / SFR + a2 Δ log e JPY / SFR + a3Δ log eeuro / SFR + a4 Δ log eWON / SFR + ε t (3)
a0,t = a0,t −1 + η0,t
(4a)
a1,t = a1,t −1 + η1,t
(4b)
a2,t = a2,t −1 + η2,t
(4c)
a3,t = a3,t −1 + η3,t
(4d)
a4,t = a4,t −1 + η4,t
(4e)
Equation (3) is the same as the OLS estimation, but coefficients are assumed to vary over time. The transition equations of coefficients are given by equations (4a), (4b), (4c), (4d) and (4e). Figure 3 shows time-varying evolution of the coefficients. The solid line shows an estimate of the coefficient while the dotted lines represent plus or minus two times the standard errors around the estimate.
McKinnon (2002) used the Kalman filter method to conduct similar estimation of East Asian currencies.
5
16
Figure 3: Results of Estimation by using Kalman Filter Method (Model Including Korean Won)
US Dollar 1.2 1.1 1 0.9 0.8 0.7 20
05
/1/4
20
05
/2/4
20
05
/3/4
20
05
/4/4
20
05
/5/4
20
05
/6/4
20
05
/7/4
20
05
/8/4
20
05
/9/4 20
05
/4 /10
20
05
/4 /11
20
05
/4 /12
20
06
/1/4
Japanese Yen 0.4 0.3 0.2 0.1 0 20
05
/1/4
20
05
/2/4
20
05
/3/4
20
05
/4/4
20
05
/5/4
20
05
/6/4
20
05
/7/4
-0.1
17
20
05
/8/4
20
05
/9/4 20
05
/4 /10
20
05
/4 /11
20
05
/4 /12
20
06
/1/4
Euro 0.3 0.2 0.1 0 20
05
8 1 7 9 5 6 5 9 0 6 2 3 0 7 4 /6 /8 /22 /20 /25 /11 /1/4 /1/3 /7/5 /2/1 /8/2 /3/1 /6/7 /1/1 /12 /6/2 /1/1 /2/1 /7/1 /8/1 /3/1 /3/2 /8/3 /4/2 /4/1 /9/1 /5/1 /9/2 /11 /5/2 /11 /12 06 05 05 05 05 /10 /10 05 05 05 05 06 05 05 05 05 05 05 05 05 05 05 05 05 05 05 05 05 05 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20
-0.1 -0.2
Korean Won 0.4 0.3 0.2 0.1 0
4 /1/ 05 20
4 /2/ 05 20
4 /3/ 05 20
4 /4/ 05 20
4 /5/ 05 20
4 /6/ 05 20
4 /7/ 05 20
4 /8/ 05 20
-0.1
1) Solid lines indicate weights on each of the currencies 2) Dotted lines indicate
±2σ
(where
σ
=standard error) lines.
Source: Ogawa and Sakane (2006)
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4 /9/ 05 20
/4 /10 05 20
/4 /11 05 20
/4 /12 05 20
4 /1/ 06 20
The coefficient on the US dollar was nearly equal to a unity before the exchange rate system reform. On the day of the exchange rate system reform, it has abruptly decreased from a unity to 0.91. It is regarded that the change is statistically significant because the change is larger than two times the standard error. However, the change is very small in the economic meanings compared with other East Asian countries (Ogawa (2004)). After the day of the exchange rate system reform, it has been a little increasing toward a unity. The increases in the standard errors after the reform imply that the Chinese yuan has less stable linkages with the US dollar compared to the period before the exchange rate system reform. The coefficients on the Japanese yen and the euro were nearly equal to zero before the exchange rate system reform. They have risen on the day of the exchange rate system reform. Especially the coefficient on the Japanese yen has statistically significant change on the day. Also standard errors of those coefficients increased on the day. However, the coefficients on the Japanese yen and the euro have been a little decreasing since the day of the exchange rate system reform. We also estimated following regression equation that excludes the term of the Korean won.
Δ log e RMB / SFR = a0 + a1Δ log eUSD / SFR + a2 Δ log e JPY / SFR + a3Δ log eeuro / SFR + ε t a0,t = a0,t −1 + η0,t
(6a)
a1,t = a1,t −1 + η1,t
(6b)
a2,t = a2,t −1 + η2,t
(6c)
a3,t = a3,t −1 + η3,t
(6d)
19
(5)
Figure 4: Results of Estimation by using Kalman Filter Method (Model without Korean Won)
US Dollar 1.2
1.1
1
0.9
0.8
0.7 /1 /7 05 20
/2 /7 05 20
/3 /7 05 20
/4 /7 05 20
/5 /7 05 20
/6 /7 05 20
/7 /7 05 20
/8 /7 05 20
/9 /7 05 20
/7 /1 0 05 20
/7 /1 1 05 20
/7 /1 2 05 20
/1 /7 06 20
Japanese Yen 0.3
0.2
0.1
0 7 3 9 5 0 6 8 9 8 1 2 0 0 4 /9 /1 1 /2 8 /1 4 /2 3 /2 5 /4 /1 /9 /2 /3 /4 /8 /5 /2 /4 /1 /6 /1 /7 /7 /8 /6 /1 /5 /2 /5 /1 /4 /2 /9 /3 /4 /1 /9 /1 /3 /1 /8 /1 /2 /1 /1 /2 /1 /2 /7 /2 /6 /2 /1 2 /1 1 /1 0 /1 0 05 05 05 05 05 /1 2 06 05 05 /1 1 05 05 05 05 05 05 05 05 05 05 06 05 05 05 05 05 05 05 05 05 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20 20
-0.1
-0.2
20
Euro 0.3
0.2
0.1
0 /1 /7 05 20
/2 /7 05 20
/3 /7 05 20
/4 /7 05 20
/6 /7 05 20
/5 /7 05 20
/7 /7 05 20
/8 /7 05 20
/9 /7 05 20
/7 /1 0 05 20
/7 /1 1 05 20
/7 /1 2 05 20
/1 /7 06 20
-0.1
-0.2
1) Solid lines indicate weights on each of the currencies 2) Dotted lines indicate
±2σ
(where
σ
=standard error) lines.
Source: Ogawa and Sakane (2006)
Figure 4 shows analytical results. The results are similar with the results in the case of regression analysis with the Korean won as an explanatory variable as shown in the figures. The coefficient on the US dollar was nearly equal to a unity before the exchange rate system reform. On the day of the exchange rate system reform, it has abruptly decreased from a unity to 0.90. It is regarded that the change is statistically significant because the change is larger than two times the standard error. However, the change is very small in the economic meanings. The coefficients on the Japanese yen and the euro were nearly equal to zero before the exchange rate system reform. They have risen on the day of the exchange rate system reform. Especially the coefficient on the Japanese yen has statistically significant change on the day. Also standard errors of those coefficients increased on the day. However, the coefficients on the Japanese yen and the euro have been a little decreasing since the day of the exchange rate system reform. As the analytical results by using daily data of exchange rates till January 25, 2006, it is found that the Chinese government has made a little change in exchange rate policy that is statistically significant. However, it is not identified that the Chinese
21
monetary authority is adopting the currency basket system because the change is too small.
6. Asymmetric Reaction of East Asian currencies to the Depreciation of the US dollar I explain a relationship between the current account deficit of the United States and the depreciation of the US dollar by focusing on sustainability of the current account deficit and capital flows to or out of the United States. The recent empirical analyses (Kudo and Ogawa (2003)) used three approaches (domestic investment-saving relationship, international trade flows, and international capital flows) of Mann (2002) to investigate unsustainability of the current account deficit of the United States. They obtained a result that the current account deficit of the United States was not sustainable from the perspectives based on both the domestic investment-saving relationships and the international trade flows. This means that the rapid growth in the current account deficit from the mid of 1990s together with the worsening international investment position has not satisfied the external “budget constraint” of the United States. However, the current account deficit of the United States has been financed by the international capital inflows. In this sense, the balance of payments as a whole has been sustainable. In other words, the portfolio investments into the United States finance the current account deficit of the United States. In the mid of 1980s, the United States economy faced the so-called twin deficits, fiscal and current account deficit, which was one of the hottest policy issues in the world economy. The ratio of the current account deficit to GDP was over 3%. The fiscal deficit was cut down by the long-term boom and political efforts during the 1990s. As a result, the federal government budget turned to surplus in 2000. On one hand, the current account deficit was decreasing till 1990. However, it was increasing and approached the level that was higher than in the mid of 1980s. In the recent years, the ratio of the current account deficit to GDP has been at the level of 6% and approached the level that was higher than in the mid of 1980s When we look at both gross capital inflows to the United States from the rest of the world and EU and gross capital outflows from the United States to the rest of the world and EU, we can find that the gross capital inflows to the United States were increasing from 1995 to 2001. However, the gross capital inflows made a sudden drop in 2001 and have been decreasing. We can find that the decrease in the gross capital inflows contribute to decreases in capital inflows from Europe if we look at another data classified by regions. Of course, the gross capital outflows are smaller in volume than
22
the gross capital inflows because net capital inflows should correspond to the current account deficit of the United States. We can find similar movements that the gross capital outflow from the United States was increasing from 1995 to 2001 and that the gross capital outflows made a sudden drop in 2001 and have been decreasing. We found that the gross capital inflows to the United States have been decreasing since 2001. If the recent changes in the capital inflows to the United States, especially the decreases in the capital inflows into the United States from European countries, were structural and persistent, the current account deficit of the United States would not be financed by the capital inflows any longer. The current account deficit of the United States would never be financed by the capital inflows if the United States made structural changes in the capital inflows. The United States’ economy would make the current account deficit unsustainable and might face a balance of payment crisis. The balance of payment crisis would take a form of large depreciation of the US dollar. Ogawa and Kudo (2004) conducted a simulation analysis to investigate how much depreciation of the US dollar is needed to reduce the current account deficit in the near future. Three VAR models were used to estimate relationships between the exchange rate of the US dollar and the current accounts in the United States. The first VAR model (Model 1) was a two-variable VAR that contains the exchange rate and the current account. In the second model (Model 2), we decompose the current account into the trade balance and the income receipt. On the other hand, from a viewpoint of the domestic investment saving balance, the third VAR model (Model 3) contains the exchange rate and the saving-investment balances for the private and the public sectors. Then the estimated VAR models were used to conduct the simulation analysis about impacts of hypothetical exchange rate movements on the current account deficit. In Ogawa and Kudo (2004) it was supposed several scenarios of exchange rate movements; 10%, 30%, and 50% of depreciation of the US dollar in the second quarter in 2004. In the case where the US dollar was sharply depreciated by 10% in the second quarter of 2004, the depreciation would gradually reduce the current account deficit to 2% of GDP by 2018 in the cases of Models 1 and 2. On one hand, it would reduce the current account deficit to 2% of GDP by 2008 in the case of Model 3. Next, in the case where the US dollar were sharply depreciated by 30% in the second quarter of 2004, the depreciation would reduce the current account deficit to 2% of GDP by 2011 and then to 1.6% of GDP in 2018 in the cases of Models 1 and 2. On one hand, it would reduce the current account deficit to 1.3% of GDP in 2008 and then increase it to 2.5% in 2020 in the case of Model 3. In the case where the US dollar was sharply depreciated by 50% in the second quarter of 2004, the depreciation would reduce the current account deficit to
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0.8% of GDP by 2013 in the case of Model 1 and to 1% of GDP by 2015 in the case of Model 2. On one hand, it would reduce the current account deficit to 0.5% of GDP in 2008 and then increase it to 2.8% in 2020 in the case of Model 3. The rest of the world should react to the depreciation of the US dollar. When we look around the movements of exchange rates of the East Asian currencies, we find asymmetric reaction to the US dollar depreciation. The Japanese yen has appreciated against the US dollar since 2002. Also the Korean won, the Thai baht, and the Singapore dollar have appreciated against the US dollar since 2002 together with the Japanese yen though they have depreciated against the Japanese yen recently. The Indonesia rupiah has appreciated against the US dollar and the Japanese yen while the Philippine peso has depreciated against the US dollar and the Japanese yen. The Chinese yuan, Hong Kong dollar, and the Malaysian ringgit have pegged to the US dollar. They have depreciated against Japanese yen after 2002 because the US dollar depreciated against the Japanese yen. One group of the countries that adopt the floating or managed floating exchange rate system faces their home currencies’ appreciation against the US dollar since 2002. The group includes Japan, Korea, Thailand, and Singapore. The other group consists of countries that adopt officially or de facto fix their home currencies to the US dollar. The group includes Malaysia, Hong Kong, and China. Their exchange rates have been fixed against the US dollar in recent years. On one hand, they have been depreciating against the currencies of the former group countries, Japanese yen, Korean won, Thai baht, and Singapore dollar due to the depreciation of the US dollar since 2002. Thus, the dollar pegging currencies carry all the stress from the depreciation of the US dollar to the more flexible exchange rate regime adopting currencies. The asymmetric reaction of the East Asian currencies to the depreciation of the US dollar should bias relative prices of products made in East Asian countries. Ogawa and Ito (2002) pointed out possibilities of coordination failure in choosing exchange rate system and exchange rate policy in a game theoretical framework as long as one country’s choosing the dollar peg system has an adverse effect on others’ choosing their own exchange rate system through relative price effects. Ogawa (2002b) conducted an empirical analysis on whether the dollar pegging currencies gave adverse effects on other East Asian countries’ choice of exchange rate system and exchange rate policy. They choose not a desirable exchange rate system but the de facto dollar peg system because the dollar pegging countries keep adopting official or de facto dollar peg systems. In other words, the monetary authorities in East Asian countries face coordination failure in choosing desirable exchange rate system
24
among East Asian countries. Accordingly, it is clear that we should make regional coordination for a desirable exchange rate regime instead of the formal or the de facto dollar peg system. It is suggested that the dollar pegging countries should adopt more flexible system such as an intermediate exchange rate system that consists of both currency basket and exchange rate band. The more flexible system means not a free floating exchange rate system but an intermediate exchange rate system that is locate between the free floating exchange rate system and the dollar peg system. It is to suggest that an intermediate exchange rate system that consists of both currency basket and exchange rate band. First, under the currency basket system, the monetary authorities should target not the US dollar but a currency basket that is composite of the US dollar, the Japanese yen, and the euro from a viewpoint of international trade partners and FDI. East Asian countries have strong economic relationship in terms of trade, FDI, and international finance with each other and European countries as well as the United States. Second, under the exchange rate band system, the monetary authorities should set a band in which the exchange rates are free floating without any intervention in the foreign exchange market. The exchange rate band can afford room for domestic monetary policy to the monetary authorities. East Asian countries have strong economic relationships with each other within the intra-region as well as the United States and European countries. It is desirable for East Asian countries to stabilize exchange rates among the intra-regional currencies and to stabilize their exchange rates against outside currencies such as the US dollar and the euro. The monetary authorities of East Asian countries coordinate their exchange rate policy to their exchange rates against the outside currencies in order to stabilize both intra-regional exchange rates and their exchange rate with outside currencies at the same time. They should care about not only the US dollar and the euro but also the Japanese yen because Japan has a larger portion in intra-regional economic relation.
7. Regional Monetary Cooperation in East Asia The asymmetric reaction of the East Asian currencies to the depreciation of the US dollar should bias relative prices of products made in East Asian countries. The monetary authorities of East Asian countries should prevent from the biased changes in the relative prices caused by the US dollar depreciation under the different exchange
25
rate systems in East Asian countries. For the purpose, they have to make coordination in choosing their exchange rate systems and exchange rate policies. Kawai, Ogawa, and Ito (2004) suggested the following three points of policy recommendation related with the exchange rate policy in East Asia. First, the monetary authorities of the ASEAN+3 should discuss the exchange rate issue as a part of the surveillance process. They should focus on the exchange rate issue as well as domestic macroeconomic policies and soundness of financial sector because exchange rates of home currency against neighbor countries’ currencies are related with its terms of trade and its price competitiveness. Each country in the East Asia region has strong economic relationships with the other intra-regional countries as well as the United States and the European countries. Exchange rates among the intra-regional currencies should affect economic activities in each country of East Asia through intra-regional trade, investments, and finance. The monetary authorities should make surveillance over not only movements of the exchange rates but also their deviations from the regional averages and, in turn, their exchange rate policy in itself. The surveillance process, in itself, might not be so robust in keeping regional policy coordination in the long run because the monetary authorities in each of the countries do not have any commitments to the policy coordination. They may make limited contribution to the policy coordination. It is necessary to have a mechanism that will be robust in keeping regional coordination in the long run by obliging the monetary authorities to have a commitment to the regional policy coordination. For the regional policy coordination, it is necessary to make all the monetary authorities in the region agree on an arrangement to create a regional common unit of account that consists of a basket of regional currencies. They might make a commitment to follow the regional common unit of account in conducting their exchange rate policy. It is desirable to create the regional common unit of account consisted of a basket of regional currencies that monetary authorities of East Asian countries should refer to when they make regional policy coordination for their exchange rate policies with each other. For the purpose, it is to introduce a regional common unit of account (Asian Monetary Unit; AMU) in East Asia. One way to do this is to construct a common currency basket that includes regional currencies of the ASEAN+3 countries. We have learnt that the monetary authorities should not de facto peg their home currencies to the US dollar from the lesson that de facto dollar-pegging countries experienced the Asian currency crisis. It is desirable for the emerging market economies in East Asia to stabilize exchange rates in terms of a G-3 currency basket (the US dollar, the euro, and the Japanese yen) because they have strong economic relationships with
26
not only the United States but also Japan and European countries. We may call targeting the G-3 currency basket as a G-3 currency basket system. The monetary authorities of the regional emerging economy countries should use their G-3 currency baskets as a common currency basket in order that they should avoid a coordination failure in choosing their exchange rate policy and exchange rate system. When the regional emerging market economies adopt a common G-3 currency basket arrangement based on the Japanese yen, the US dollar and the euro, the AMU will also become a de
facto basket of the G-3 currencies. This will create a zone of currency stability within East Asia. In addition, regional currency arrangements to target their home currencies to the common G-3 currency basket will help prevent competitive devaluation among the currencies in a region because the monetary authorities have a commitment to the arrangements.
8. AMU and AMU Deviation Indicator Ogawa and Shimizu (2004) suggested that the monetary authorities of East Asian countries should use the AMU and its deviation measurements for each of the East Asian currencies to make surveillance at the Finance Ministers’ meeting of ASEAN+3. For the purpose, the ASEAN+3 currencies should be chosen as the component currencies of the AMU. The weight of each currency in the basket is based on countries’ respective share in regional GDP measured at PPP and their trade volume share (the sum of exports and imports) in 2001-2003 in order to reflect the most recent trade relationships and economic conditions of the thirteen East Asian countries for calculation of the AMU. A value of the AMU should be quoted in terms of a weighted average of the US dollar and the euro because both the United States and EU countries are important trading partners for East Asia. The weighted average of the US dollar and the euro (hereafter, US$-euro) is based on the East Asian countries’ trade volumes with the United States and the euro area. The weights on the US dollar and the euro are set at 65% and 35%, respectively. Next, a benchmark period should be chosen in order to calculate AMU Deviation Indicators based on the following criterion: the total trade balance of member countries, the total trade balance of member countries (excluding Japan) with Japan, and the total trade balance of member countries with the rest of world should be close to zero. When we look at the trade accounts of the thirteen East Asian countries from 1990 to 2003, the trade accounts were closest to balance in 2001. Assuming a one-year time
27
lag before changes in exchange rates affect trade volumes, we should choose 2000 and 2001 as the benchmark period. For the benchmark period, the exchange rate of the AMU in terms of the US$-euro is set at unity. We define the exchange rate of each East Asian currency in terms of the AMU during the benchmark period as the Benchmark Exchange Rate.
28
In summary, the AMU weights are calculated based on both the arithmetic shares of trade volumes and GDP measured at PPP for 2001-2003. The Benchmark Exchange Rate for each currency is defined in terms of the AMU during 2000-2001. We define the nominal exchange rate of the AMU in terms of the US$-euro as the weighted sum of each country's US$-euro exchange rate using the AMU weights in Table 2, which shows the AMU weights as well as trade volumes, GDP measured at PPP, arithmetic shares, and the Benchmark Exchange Rates. We can use them to calculate an exchange rate for the AMU in terms of the US$-euro as follows:
US $ + euro
+ 7.4235US $ + euro + 2.7711US $ + euro BN $ CBR CNY + 452.7871US $ + euro + 30.5681US $ + euro + 113.1459 US $ + euro IDR JPY KRW $ US $ + euro US $ + euro US euro + + 0.0239 + 5.9500 + 0.1953 MLR MYK LOK US $ + euro US $ + euro US $ + euro + 1.3347 + 0.1075 + 2.0630 PLP SP$ TLB + 243.0432 US $ + euro VTD
AMU
= 0.0069US $ + euro
where US$-euro: a currency basket of 65% of the US dollar and 35% of the euro, BN$: Brunei dollar, CBR: Cambodia riel, CNY: Chinese yuan, IDR: Indonesian rupiah, JPY: Japanese yen, KRW: Korean won, LOK: Laos kip, MLR: Malaysian ringgit, MYK: Myanmar kyat, PLP: Philippine peso, SP$: Singapore dollar, TLB: Thailand baht, VTD: Vietnamese dong. Figure 5 shows daily movements in the nominal exchange rate of the AMU in terms of the US$-euro. For reference, we add daily movements in both of the nominal exchange rates of the AMU in terms of the US dollar and the euro. Also, we can show exchange rates of the East Asian currencies in terms of the AMU. We can compare their movements with those of exchange rates of the East Asian currencies in terms of the US dollar and the euro.
29
Figure 5: AMU in Terms of the Currency Basket of the US dollar and the euro
30
A nominal exchange rate of each East Asian currency in terms of the AMU is used to calculate a Nominal AMU Deviation Indicator (%). It indicates how far each East Asian currency i deviates from the Benchmark Exchange Rate in terms of the AMU, which is a weighted average of East Asian currencies. The Nominal AMU Deviation Indicator is calculated as follows: Nominal Deviation Indicator (%) =
actual exchange rate of AMU
a currency
- benchmark exchange rate of AMU
benchmark exchange rate of AMU
a currency
×100
a currency
Figure 6 shows movements in the Nominal AMU Deviation Indicators on a daily basis.
Figure 6: Nominal AMU Deviation Indicators
31
(1)
Next, we calculate an AMU Deviation Indicator in real terms by taking into account inflation rate differentials. Given that the Nominal AMU Deviation Indicator is defined as equation (1), we calculate a Real AMU Deviation Indicator according to the following equation:
(2)
where
: inflation rate in the AMU area,
: inflation rate in country i.
The Consumer Price Index (CPI) is used to calculate the Real AMU Deviation Index, which can therefore only be computed on a monthly basis with a 5 to 6 month time lag due to data constraints. 6 As for the inflation rate in the AMU area, we calculate a weighted average of the CPI for the AMU area using the AMU shares. Figure 7 shows the movement in the Real AMU Deviation Indicator on a monthly basis for each of the East Asian currencies.
Figure 7: Real AMU Deviation Indicators
Korea
CPI data are used as the price index because in some of the countries no other price data are available. There is also a 5 to 6 month time lag until CPI data for all countries are available.
6
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When we look at the Real AMU Deviation Indicator, we find that inflation makes the related currency appreciate in real terms while deflation makes it depreciate in real terms. For example, while the Indonesian rupiah, the Laos kip, and the Korean won have appreciating in nominal terms, they have larger depreciating deviation in real terms. On one hand, while the Philippine peso and Vietnamese dong have over 10 percent depreciating in nominal terms, they have smaller depreciating deviation in real terms. These findings indicate that we have to monitor both the nominal and real deviation indicators carefully for surveillance over intra-regional exchange rates among the East Asian countries. We consider what are merits and demerits for each of the nominal and real deviation indicators. From the viewpoint of data frequency, nominal deviation indicators can be monitored in real time. We are able to use them as the indicator of daily surveillance for the monetary authorities. On the other hand, real deviation indicators are available only on a monthly basis and there might be some time lags (five or six months lags) when we obtain the real deviation indicators. The Real AMU Deviation Indicator is more appropriate when considering the effects of exchanges on real economic variables such as trade volumes and real GDP. On the other hand, the Nominal AMU Deviation Indicator is more useful when it is important to monitor exchange rate movements on a timely basis. Accordingly, the Nominal and Real AMU Deviation Indicators should be regarded as complementary measures for the surveillance of exchange rate policy and related macroeconomic variables and, in turn, for devising coordinated exchange rate policies among the East Asian countries.
9. Multi-step approach toward a common currency in East Asia A multi-step approach toward a common currency should be taken in East Asia because we take into account facts that ASEAN+3 countries have launched to make regional monetary cooperation under the Chiang Mai Initiative and that it took fifty years for European countries introduce a common currency, the euro, into the Euro Area since the establishment of the ECSC in 1951. Moreover, it is often pointed out that East Asian countries have different stages of economic developments. Accordingly, East Asian countries should take a multi-step approach toward a common currency in terms of “deepening and widening.” As for a multi-step approach in terms of “deepening”, the following steps
33
should be taken for East Asian countries. At the first step, ASEAN+3 make policy dialogue about exchange rates and exchange rate policies and surveillance over them at EPRD of ASEAN+3 Finance Ministers’ Meeting. At the time, they can use AMU and AMU Deviation Indicator for their surveillance process. At the second step, ASEAN+2(China and Korea) adopt managed floating exchange rate system with reference of individual G3 currency (the US dollar, the euro, and the Japanese yen) basket. The reason why Japanese yen should be excluded at the earlier stages of adopting common exchange rate system is different stages of economic developments between Japan and the other countries. Next, exchange rate policy should be common in order to stabilize intra-regional exchange rates. At the third step, ASEAN+2 adopt managed floating exchange rate system with reference of a common G3 currency basket. At the fourth step: ASEAN+2 fix home currency to a common G3 currency basket After some of the other East Asian countries approached to the some stage of economic development with Japan, Japan and the other countries will be able to adopt a common exchange rate policy and fix intra-regional exchange rates among the currencies. At the fifth step, they start to fix their home currencies to the AMU and make coordinated intervention against G2 currency basket. In order to keep this common exchange rate policy without any troubles, the participant country economies should
satisfy
conditions
for
the
optimum
currency
area
(Mundell(1961),
McKinnon(1963), Bayoumi and Eichengreen (1993), Bayoumi, Eichengreen and Mauro (2000), Kawasaki and Ogawa (2006)). As for a multi-step approach in terms of “widening”, we should take into account different stages of economic developments not only between Japan and the other East Asian countries but also among the East Asian counties excluding Japan. At the above-mentioned second, third, and fourth steps, only ASEAN+2 countries should take stepwise measures toward a common exchange rate policy. At the fifth step, the ASEAN+3 countries launch to adopt a common exchange rate policy. In this situation, central banks of the countries will have no longer independence of monetary policy. Some central banks might not yet follow the monetary policy that is taken by central banks of disinflationary core countries. We had better classify the AEAN+3 countries into core countries and periphery countries. Only core countries should take the same disinflationary monetary policy and a common exchange rate policy. Periphery countries should target the AMU with exchange rate band or adopt a managed floating exchange rate system with reference to the AMU.
34
10. Conclusion In this paper, we overviewed the current financial and monetary cooperation (the Chiang Mai Initiative) in East Asia. The Chiang Mai Initiative includes a currency swap arrangements for a currency crisis management and a surveillance process for a currency crisis prevention. After we overviewed the current Chiang Mai Initiative, we proposed further developments of the Chiang Mai Initiative. Moreover, we discussed a desirable exchange rate system for East Asian countries. It is proved that a currency basket system is desirable for East Asian countries after we take into account a fact that East Asian economies have strong economic relationships with intra-regional countries, the United States, and European countries. We investigated actual exchange rate systems that are adopted by the monetary authorities of East Asian countries. We focused on the Chinese exchange rate system reform that was announced on July 21, 2005. The Chinese government announced to shift from dollar peg system to a managed floating managed floating exchange rate system with reference to a currency basket. However, our empirical analysis showed that the Chinese monetary authority has little changed its exchange rate policies in terms of targeting the US dollar. We pointed out unsustainability of the US current account deficits and possibilities of depreciating US dollar. Also, we pointed out that East Asian currencies will have asymmetric reaction to the deflationary US dollar under the current variety of exchange rate systems of East Asian currencies. The situation is called as “coordination failure” in choosing a desirable exchange rate system. We pointed out necessity of making policy coordination to solve the coordination failure. We proposed a regional monetary cooperation in East Asia, which includes strengthening the surveillance process and introducing a regional common unit of account that is called as Asian Monetary Unit (AMU). We explain details of AMU and AMU Deviation Indicators. A combination of both stabilizing value of the AMU in terms of a currency basket of the US dollar and the euro and decreasing of AMU Deviation Indicator of each of East Asian currencies make the relevant East Asian currency stabilize but both intra-regional exchange rates and the AMU in terms of a currency basket of the US dollar and the euro. We propose a multi-step approach toward a common currency in East Asia. The multi-step approach should be taken in terms of both “deepening and widening.”
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