Exchange Rate Regimes and
Monetary Policy:
Options for China and East Asia
Takatoshi Ito, University of Tokyo
and RIETI, and
Eiji Ogawa, Hitotsubashi
University, and RIETI
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Contents
„
„
„
„
„
Theory: Impossible Trinity
Theory: IS-balance
Theory: Balassa-Samuelson
Exchange Rate Policy in China
AMU and Deviation Measurement for
coordinated exchange rate policies.
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Theory I: relationship between the
exchange rate & Monetary Policy
„
„
„
„
Choosing one exchange rate regime puts
constraints on monetary policy, sometime
severe, sometime moderate
The fixed exchange rate regime implies that
domestic monetary policy cannot pursue
domestic price stability
Monetary policy will influences on (pressures
on) the exchange rate movements
Pursuit of monetary policy inconsistent with
the exchange rate regime will result in a
collapse of the regime.
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Impossible Trinity: cannot have
capital mobility, fixed exch rate &
independent Monetary Policy
China
Capital
mobility
No
Fixed Exch Independen
rate
t M policy
Yes
Yes
Korea, Thai, Yes
Singapore
No
Yes
Hong Kong
Yes
No
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Yes
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Why impossible?
Lessons from the Asian Crisis
„
„
Suppose (yes, yes, yes)
Strong growth Æ Capital inflows Æ intervene
to defend the peg
„
„
„
Sterilize (not to change the interest rate and
domestic inflation) then more capital inflows with
increasingly short-term
Unsterilize (so that inflow pressure will ease) then
domestic inflation and bubble
Either exit to appreciation or sudden reversal
of the flow and currency crisis
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Theory II:
Saving Investment Identity
„
Domestic Saving-Investment surpluses
= Trade Surpluses:
„
„
(S-I) + (T-G) = Export – Import
Any Surpluses/deficits in current
account has corresponding capital flows
„
(Ex-Im) = Private Capital Outflows +
Reserve accumulation
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Examples
(S-I)+(T-G)=(EX-IM)=KOutflo+ResAcc
„
„
„
„
Japan +++ -China ++ US
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-
--
--
0
+
+
0
+
--
+++
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Implications of theory
„
„
„
Sudden government deficits result in
current account deficits (twin deficits of
the US)
Decline in domestic spending result in
current account surpluses and capital
outflow (Japan)
More capital inflows means more
reserve accumulation (China)
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Theory III: Balassa-Samuelson
„
Empirical regularities:
„
„
„
„
When the economy is growing very fast (Japan in
the 1960s and China now), innovations tend to
occur tradable sectors relative to nontradable
sectors
Relative prices change so that nontradable prices
go up faster than tradable prices
Tradable prices have PPP with foreign countries
Relevance to China: Inflation or nominal
exchange rate appreciation
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Is the fixed exchange rate
regime good for the country?
„
Foreign reserves will increase and decrease
depending on current accounts and private
capital flows (interventions are passive)
„
„
Unsustainable if reserves go to zero (not likely in
China)
Domestic monetary policy is at the mercy of
FRB; the Interest rate cannot be much
different from the US
„
„
Low interest rate Æ bubble
High interest rate Æ recession
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Timing of exit
„
When the economy is growing very fast
(Japan in the 1960s and China now),
innovations tend to occur tradable sectors
relative to nontradable sectors
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If not peg, what else?
„
„
„
Review of the Exchange rate regimes in
East Asia
Important to recognize that East Asia
depends on each other and influence on
each other
Chinese exchange rate policy has a
large impact on East Asia
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A variety of exchange rate
regimes in East Asia
„
„
„
„
„
Free (lightly managed) float: Japan,
Korea, the Philippines, Singapore
(Heavily) Managed float: Indonesia,
Thailand, Cambodia, Lao, Vietnam
Fixed: China, Malaysia
Currency board: Hong Kong, Brunei
Multiple Exchange Rates: Myanmar
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Recent linkages of East Asian
currencies to US$
Regression equation:
∆ log e hom e / SFR = a0 + a1∆ log eUSD / SFR + a2 ∆ log e JPY / SFR + a3∆ log eeuro / SFR + ε t
Use daily data to regress the equation for each quarter
of the sample period from 1999 to 2003.
a1 : linkages of home currency to the US$ or weight
on the US$
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Thai baht’s linkage to US$
Change of the Weight on US dollar - Thai baht, 1999.1Q-2003.4Q Weight on
US dollar
（%）
140
Weight on US dolalr
Weight on US dolalr + 2*Standard errors
Weight on US dolalr - 2*Standard errors
120
100
80
60
40
20
0
1999
1999
1999
1999
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2000
2000
2000
2001
2001
2001
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2002
2002
2003
2003
2003
2003
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Korean won’s linkage to US$
Change of the Weight on US dollar - Korean won, 1999.1Q-2003.4Q Weight on
US dollar
（%）
140
Weight on US dolalr
Weight on US dolalr + 2*Standard errors
Weight on US dolalr - 2*Standard errors
120
100
80
60
40
20
0
1999
1999
1999
1999
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2000
2000
2000
2001
2001
2001
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2002
2002
2003
2003
2003
2003
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Chinese yuan: weights on US$
Change of the Weight on US dollar - Chinese Yuan, 1999.1Q-2003.4Q Weight on
US dollar
（%）
140
Weight on US dolalr
Weight on US dolalr + 2*Standard errors
Weight on US dolalr - 2*Standard errors
120
100
80
60
40
20
0
1999
1999
1999
1999
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2000
2000
2000
2001
2001
2001
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2002
2002
2003
2003
2003
2003
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Capital inflows have supported
unsustainable US CA deficits
The US current account deficit was not sustainable from
the perspectives based on both the domestic
investment-saving relationships and the international
trade flows.
=> 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.
„
The US current account deficit has been financed by the
international capital inflows in the long run.
=> The balance of payments as a whole has been
sustainable.
„
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Structural changes in the capital
flows and the US CA deficits
„
„
If the recent changes in the capital inflows to the
United States (the decreases in the capital
inflows into the United States from European
countries) were structural and persistent, the U.S.
current account deficits might not be financed by
the capital inflows any longer.
It might cause unsustainability of the US current
account and, in turn, depreciation of the US$.
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Reaction to the US$ depreciation
Two groups in terms of reaction to the US
dollar depreciation in East Asia
(1)
Free floating or managed floating: the
currencies have appreciated against the US
dollar
(2)
Officially or unofficially dollar pegging: the
currencies have been fixed against the US
dollar. However, they have been depreciating
the former group currencies.
„
The latter group carry all of the stress from
the depreciation of the US dollar to the
former
group.
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„
Chinese exchange rate system
„
„
„
1.
2.
3.
Adverse effects of the Chinese exchange rate
system to the other East Asian countries’ choice of
the exchange rate system
China should adopt more flexible system
Intermediate system (Basket + Band + Crawling)
Target a currency basket (US$, JPY, euro) from a
viewpoint of international trade partners and FDI
Band can afford room for domestic monetary
policy to the monetary authorities.
Crawling should be consistent with the domestic
monetary policy.
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AMU as a measurement for
coordinated exchange rate policies
„
„
„
„
We propose a deviation measurement for
coordinated exchange rate policies to enhance
the monetary authorities’ surveillance process.
Estimate Asian Monetary Unit (AMU), a weighted
average of the East Asian currencies.
Calculate deviation indicators from benchmark
rate for the estimated AMU.
We can use the deviation indicators to identify
how much each of the East Asian currencies
deviates from the benchmark rate for each of
East Asian currencies in terms of the AMU.
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Methodology to estimate the
AMU
„
Member countries
ASEAN10 + Japan, China and Korea
„
Sampled period
from January 1999 to November 2004
„
To follow the methodology to
calculate the ECU
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The basket weights of AMU
„
We try to use four different kinds of
economic indicators.
1.
2.
3.
4.
„
Trade volume
Nominal GDP
GDP measured at PPP
International reserves (minus Gold)
We choose the most stable AMU vis-àvis the basket currency among them.
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Shares in the AMU weights and
calculated AMU weights
Table 2. Indicators of AMU weights and calculated AMU weights (AMU vis-a-vis the basket currency*)
Exchange Rate
currency units for
1basket currency*
ave. of Jan 1999
BRUNEI $
CAMBODIA
RIEL
CHINESE
YUAN
INDONESIAN
RUPIAH
JAPANESE
YEN
KOREAN
WON
LAOS KIP
1.7797
4065.79
8.7800
8974.89
120.07
1246.11
4457.56
4.0316
6.6309
40.7302
MALAYSIAN MYANMAR PHILIPPINE SINGAPORE
RINGGIT
KYAT
PESO
$
THAI
BAHT
VIETNAMESE
DONG
1.7800
38.9109
14726.17
＜Indicators of AMU weights, %＞
Share of trade volume
0.29
0.33
14.22
3.38
26.94
11.35
0.18
11.91
0.58
5.69
15.88
7.04
2.20
Share of Nominal GDP
0.07
0.05
16.81
1.68
69.40
5.65
0.02
1.27
-
1.15
1.45
1.97
0.48
Share of GDP
measured at PPP
0.04
0.15
47.06
4.51
32.45
5.68
0.06
1.61
-
2.52
0.90
3.42
1.60
Share of International
Reserves
0.07
0.06
27.41
4.17
39.59
6.78
0.02
4.70
0.06
1.70
9.78
5.30
0.37
Share of trade volume
0.0052
13.4707
1.2484
303.6043
32.3517
141.4752
8.1922
0.4802
0.0382
2.3161
0.2827
2.7391
323.7570
Share of Nominal GDP
0.0012
2.0832
1.4757
150.8786
83.3317
70.3876
1.0089
0.0513
0.0000
0.4675
0.0258
0.7666
70.5763
Share of GDP
measured at PPP
0.0008
6.0301
4.1321
404.6478
38.9575
70.7321
2.6761
0.0650
0.0000
1.0276
0.0160
1.3300
235.8054
Share of International
Reserves
0.0012
2.4205
2.4068
374.5547
47.5370
84.5175
0.9173
0.1893
0.0038
0.6905
0.1740
2.0609
54.1708
＜AMU weights＞
Notes: All figures are calculated by authors. Nominal GDP and International Reserves (minus Gold) data are from International Financial Statistics, IMF. All trade data are from Direction of Trade of IMF. GDP measured
at ppp are from World Development Report, World Bank. All exchange rates are from Datastream. Indicators of AMU weights are calculated by the data in 1998.
* The basket currency is composed by the US dollar and the euro. The basket weight is depend on the trade share of each country/area against 13 sampled East Asian countries. Each weights is
51.7% and 48.3% for the US dollar and the euro, respectively.
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Fluctuations in AMUs (vis-àvis basket currency)
Figure 3. The estimated AMU vis-a-vis the basket currency Feb 1999-Nov 2004
AMU v.s. basket currency
Jan 1999=1
1.2
AMU-trade volume weight
AMU-nominal GDP weight
AMU-GDP measured at ppp weight
AMU-international reserve weight
AMU-nominal GDP weight
1.15
1.1
AMU-GDP measured at ppp weight
1.05
AMU-international reserve weight
1
AMU-trade volume weight
0.95
2004/10/1
2004/8/1
2004/6/1
2004/4/1
2004/2/1
2003/12/1
2003/10/1
2003/8/1
2003/6/1
2003/4/1
2003/2/1
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2002/12/1
2002/10/1
2002/8/1
2002/6/1
2002/4/1
2002/2/1
2001/12/1
2001/10/1
2001/8/1
2001/6/1
2001/4/1
2001/2/1
2000/12/1
2000/10/1
2000/8/1
2000/6/1
2000/4/1
2000/2/1
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1999/12/1
1999/10/1
1999/8/1
1999/6/1
1999/4/1
1999/2/1
0.9
26
Choose the most stable AMU
Table 3. Fluctuation of estimated AMU vis-a-vis the basket currency*
Share of trade
volume
Share of Nominal
Share of GDP
GDP
measured at PPP
Share of
International
Reserves
<level>
max
min
average
std. dev.
<rate of change, %>
max
min
average
std. dev.
1.1320
0.9463
1.0169
0.0486
1.1847
0.9516
1.0345
0.0566
1.1519
0.9644
1.0348
0.0478
1.1520
0.9590
1.0306
0.0481
1.2677
-2.0006
-0.0021
0.3173
2.3127
-2.5231
0.0012
0.4718
1.2113
-2.0024
-0.0016
0.3106
1.4524
-2.1157
-0.0007
0.3464
Notes: All figures are calculated by authors.
* The basket currency is composed by the US dollar and the euro. The basket weight is depend on the trade share of
each country/area against 13 sampled East Asian countries. Each weights is 51.7% and 48.3% for the US dollar and the
euro, respectively.
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Measurement of the deviation
indicators
„
We use the estimated AMUs with the
weights based on
GDP measured at PPP
Trade volume
to measure the deviation of actual rate
from a benchmark rate for 13 East
Asian currencies.
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To choose the benchmark
period for AMU
„
In the benchmark period, the total
current account of trade should be
balanced, or more close to be balanced.
Table 4. Trade account (net) within 13 East Asian countries
13 East Asian countries
with Japan *
within 13 East Asian countries
with World Total
1999
2000
2001
2002
2003
-32,065
-37,239
-23,997
-40,027
-55,724
4,819
-6,562
1,953
12,289
27,727
215,324
180,439
122,893
160,906
187,868
(unit: million of US dollar)
Notes: All figures are calculated by authors. Trade data are from Direction of Trade (IMF).
* The figure of current account with Japan is the total amount of current account(net) with 12 East Asian countries.
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How to calculate
the deviation indicator
„
Using the estimated AMU, we calculate the
deviation indicator as follows:
benchmark rate : each currency’s exchange rate vis-à-vis
AMU at the benchmark period
actual exchange rate : exchange rate of each currency
vis-à-vis AMU which fluctuates as the each currency
actually move
Deviation Indicator (%)
=
benchmark rate of a currency/A MU - actual exchange rate of a currency/A MU
× 100
benchmark rate of a currency/A MU
(1)
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The deviation indicators
in the case of AMU based on GDP measured at PPP
Figure4. The movement of the deviation indicators from January 2002 to November 2004
(%)
(in the case of AMU weight based on GDP measured at PPP)
20.0
Indonesian rupiah
15.0
10.0
BRUNEI $
Korean
won
Japanese yen
CAMBODIA RIEL
5.0
CHINESE YUAN
Thai baht
Singapore$ Brunei$
INDONESIAN
RUPIAH
JAPANESE YEN
0.0
Malaysian ringgit
Myanmar kyat
KOREAN WON
-5.0
LAOS KIP
Chinese yuan
Laos kip
MALAYSIAN
RINGGIT
MYANMAR KYAT
-10.0
Cambodia riel
Vietnamese dong
PHILIPPINE
PESO
SINGAPORE $
-15.0
Philippine peso
THAI BAHT
-20.0
VIETNAMESE
DONG
2004/11/1
2004/10/1
2004/9/1
2004/8/1
2004/7/1
2004/6/1
2004/5/1
2004/4/1
2004/3/1
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2004/2/1
2004/1/1
2003/12/1
2003/11/1
2003/10/1
2003/9/1
2003/8/1
2003/7/1
2003/6/1
2003/5/1
2003/4/1
2003/3/1
2003/2/1
2003/1/1
2002/12/1
2002/11/1
2002/9/1
2002/10/1
2002/8/1
2002/7/1
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2002/6/1
2002/5/1
2002/4/1
2002/3/1
2002/2/1
2002/1/1
-25.0
31
The deviation indicators
in the case of AMU based on trade volume
Figure5. The movement of the deviation indicators from January 2002 to November 2004
(%)
(in the case of AMU weight based on trade volume)
20.0
Indonesian rupiah
15.0
10.0
BRUNEI $
Korean won
Japanese yen
5.0
CAMBODIA RIEL
CHINESE YUAN
0.0
Thai baht
INDONESIAN
RUPIAH
JAPANESE YEN
Singapore$
B
i$
-5.0
KOREAN WON
Malaysian ringgit
Myanmar kyat
LAOS KIP
-10.0
Chinese yuan
Cambodia riel
-15.0
MALAYSIAN
RINGGIT
MYANMAR KYAT
Laos
Vietnamese dong
PHILIPPINE
PESO
SINGAPORE $
Philippine peso
THAI BAHT
-20.0
2004/11/1
2004/10/1
2004/9/1
2004/8/1
2004/7/1
2004/6/1
2004/5/1
2004/4/1
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2004/3/1
2004/2/1
2004/1/1
2003/12/1
2003/11/1
2003/10/1
2003/9/1
2003/8/1
2003/7/1
2003/6/1
2003/5/1
2003/4/1
2003/3/1
2003/2/1
2003/1/1
2002/12/1
2002/11/1
2002/9/1
2002/10/1
2002/8/1
3/19/2005
2002/7/1
2002/6/1
2002/5/1
2002/4/1
2002/3/1
2002/2/1
2002/1/1
-25.0
VIETNAMESE
DONG
32
Nominal and
Real Deviation Indicators
„
„
We should take into account inflation
rate differentials if we consider real
effect of exchange rates on trade, FDI
and real economic activities (real GDP).
We calculate also deviation indicators in
real terms by taking into account
inflation rate differentials.
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How to calculate Real
Deviation Indicator
„
We define the real and nominal exchange rate as follows:
rex i = nex i ⋅
PAMU
Pi
, nex i ≡
currency
(2)
i
AMU
where rex : real exchange rate , n ex : no min al exchange rate
then in terms of rates of change,
r e&x i = n e&x i − ( p&i − p&AMU
„
)
(3)
We can calculate real deviation indicator as follows:
(
)
real deviation indicator i = no min al deviation indicator i − P&AMU − P&i
„
(4)
We use CPI data as both prices and the inflation rate.
CPI of AMU: weighted CPI of member countries
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The differences between
nominal and real indicators
„
„
„
The inflation makes the related currency
appreciate in real terms while deflation makes
it depreciate in real terms.
The Chinese yuan has the largest depreciating
deviation in real terms in 6/2003(5,6/2003 in
AMU with trade volume) although it has not so
largely depreciating deviation in nominal terms.
The Japanese yen appreciates by nearly 5
percent in 2004 in nominal term although it
stays around 0 or even depreciates in real
terms due to deflation in Japanese economy.
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Nominal deviation indicator
in the case of AMU based on GDP measured at PPP
Figure6. The movement of nominal deviation indicators from January 2002 to November 2004
(%)
(in the case of AMU weight based on GDP measured at PPP, monthly change)
25.0
20.0
BRUNEI $
Indonesian rupiah
CAMBODIA RIEL
15.0
CHINESE YUAN
Korean won
10.0
INDONESIAN
RUPIAH
Japanese yen
JAPANESE YEN
5.0
KOREAN WON
Thai baht
0.0
LAOS KIP
Singapore$ Brunei$
MALAYSIAN
RINGGIT
Malaysian ringgit
Chinese yuan
-5.0
PHILIPPINE
PESO
Laos kip
Cambodia riel
-10.0
SINGAPORE $
Vietnamese dong
-15.0
THAI BAHT
VIETNAMESE
DONG
Philippine peso
-20.0
-25.0
11/2004
10/2004
9/2004
8/2004
7/2004
6/2004
5/2004
4/2004
3/2004
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2/2004
1/2004
12/2003
11/2003
10/2003
9/2003
8/2003
7/2003
6/2003
5/2003
4/2003
3/2003
2/2003
1/2003
12/2002
11/2002
10/2002
9/2002
8/2002
7/2002
6/2002
5/2002
4/2002
3/2002
2/2002
1/2002
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Real deviation indicator
in the case of AMU based on GDP measured at PPP
Figure 7. The movement of real deviation indicators from January 2002 to November 2004
(%)
(in the case of AMU weight based on GDP measured at PPP, monthly change)
35.0
30.0
Indonesian rupiah
BRUNEI $
CAMBODIA RIEL
25.0
CHINESE YUAN
20.0
Laos kip
INDONESIAN
RUPIAH
JAPANESE YEN
15.0
KOREAN WON
Korean won
10.0
LAOS KIP
Thai baht
5.0
MALAYSIAN
RINGGIT
Japanese yen
PHILIPPINE
PESO
SINGAPORE $
0.0
Singapore $ Brunei$
THAI BAHT
Vietnamese dong
-5.0
VIETNAMESE
DONG
Chinese yuan
Malaysian ringgit
-10.0
Philippine peso
Cambodia riel
-15.0
7/2004
6/2004
5/2004
4/2004
3/2004
2/2004
1/2004
12/2003
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11/2003
10/2003
9/2003
8/2003
7/2003
6/2003
5/2003
4/2003
3/2003
2/2003
1/2003
12/2002
11/2002
10/2002
9/2002
8/2002
7/2002
6/2002
5/2002
4/2002
3/2002
2/2002
1/2002
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Nominal deviation indicator
in the case of AMU based on Trade weight
Figure8. The movement of nominal deviation indicators from January 2002 to November 2004
(%)
(in the case of AMU weight based on trade volume, monthly change)
25.0
20.0
BRUNEI $
CAMBODIA RIEL
15.0
Indonesian rupiah
CHINESE YUAN
10.0
INDONESIAN
RUPIAH
Korean won
Japanese yen
JAPANESE YEN
5.0
KOREAN WON
Thai baht
0.0
LAOS KIP
Singapore $ Brunei$
-5.0
MALAYSIAN
RINGGIT
Malaysian ringgit
PHILIPPINE
PESO
Chinese yuan
SINGAPORE $
Laos kip
-10.0
Cambodia riel
THAI BAHT
Vietnamese dong
-15.0
VIETNAMESE
DONG
-20.0
Philippine peso
-25.0
11/2004
10/2004
9/2004
8/2004
7/2004
6/2004
5/2004
4/2004
3/2004
RIETI-BIS Conference
2/2004
1/2004
12/2003
11/2003
10/2003
9/2003
8/2003
7/2003
6/2003
5/2003
4/2003
3/2003
2/2003
1/2003
12/2002
11/2002
10/2002
9/2002
8/2002
7/2002
6/2002
5/2002
4/2002
3/2002
2/2002
1/2002
3/19/2005
38
Real deviation indicator
in the case of AMU based on Trade weight
Figure9. The movement of real deviation indicators from January 2002 to November 2004
(%)
(in the case of AMU weight based on trade volume, monthly change)
30.0
BRUNEI $
Indonesian rupiah
CAMBODIA RIEL
CHINESE YUAN
20.0
INDONESIAN
RUPIAH
Laos kip
JAPANESE YEN
KOREAN WON
10.0
Korean won
LAOS KIP
Thai baht
MALAYSIAN
RINGGIT
Japanese yen
PHILIPPINE
PESO
0.0
Singapore $ Brunei$
SINGAPORE $
THAI BAHT
Chinese yuan
Vietnamese dong
Cambodia
riel
-10.0
Malaysian ringgit
VIETNAMESE
DONG
Philippine peso
-20.0
7/2004
6/2004
5/2004
4/2004
3/2004
2/2004
1/2004
12/2003
RIETI-BIS Conference
11/2003
10/2003
9/2003
8/2003
7/2003
6/2003
5/2003
4/2003
3/2003
2/2003
1/2003
12/2002
11/2002
10/2002
9/2002
8/2002
7/2002
6/2002
5/2002
4/2002
3/2002
2/2002
1/2002
3/19/2005
39
Conclusion
„
„
„
The fixed exchange rate regime implies no
independent monetary policy.
When strong capital inflows occur, it is difficult to
maintain the peg: Sterilizing intervention will
maintain the interest rate but that encouraged
more capital inflows; and unsterilized intervention
will fuel domestic inflation.
When the economy is growing very fast (Japan in
the 1960s and China now), innovations tend to
occur tradable sectors relative to nontradable
sectors
3/19/2005
RIETI-BIS Conference
40
Conclusion
„
„
„
China should adopt more flexible system, an
intermediate system (Basket + Band +
Crawling)
A variety of exchange rate system in East
Asia cause misalignments among East Asian
currencies.
We propose a deviation measurement from
the AMU for coordinated exchange rate
policies to enhance the monetary authorities’
surveillance process.
3/19/2005
RIETI-BIS Conference
41