ASEAN income gap and the optimal exchange Rate Regime

Ngoc Nguyen, Charles Harvie and Sandy Suardi

Applied Economics, 2020, vol. 52, issue 3, 288-304

Abstract: This article investigates the optimal exchange rate regime in a group of ASEAN countries, which minimizes the adverse effects of foreign demand shocks on real output, the real exchange rate, price level and between-country income gap. Using a panel structural vector autoregressive model for small open economies, we show that the extent by which foreign demand shocks influences the between-country income gap depends on the exchange rate regime and the transmission channels through output, the price level and the real exchange rate. Our results show that a fixed exchange rate is better in insulating output and real exchange rates against adverse foreign demand shocks. Nevertheless, a flexible exchange rate regime achieves lower inflation and narrows the income gap across countries. Further, foreign demand shocks explain a larger portion of the forecast error variance of macroeconomic variables under a fixed than under a flexible exchange rate regime.

Date: 2020
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DOI: 10.1080/00036846.2019.1645278

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