Choice of exchange rate system and macroeconomic volatility of three Asian emerging economies

Hui-Boon Tan and Lee-Lee Chong

Macroeconomics and Finance in Emerging Market Economies, 2008, vol. 1, issue 2, 167-179

Abstract: This study highlights the importance of choice of exchange rate system to macroeconomic stability of small-open emerging economies based on the outcomes of the recent exchange rate regime switches of three Asian countries - Indonesia, Malaysia, and Thailand. These countries have high similarities in their economic structures, but have reacted very differently in mitigating the economic distortion of the 1997 financial crisis, in particular in the adoption of exchange rate system. The empirical results of this study show that the amplified instability of macro-variables in Thailand and Indonesia, which was due to the crisis, were not stabilized by switching the exchange rate system to a flexible regime. The volatilities, however, were effectively stabilized after the countries made the second switch - from the independent float to the managed float with no pre-announcement. For Malaysia, a switch from the managed float to the pegged system successfully reduced the volatilities. The exchange rate misalignments of the countries, except Indonesia, were also reduced when the countries switched from a flexible to a more fixed managed float system. These empirical findings thus strongly support central banks of small-open emerging economies to adopt a more fixed, rather than a more flexible system. However, the managed float system needs to couple with efficient management to ensure a smooth and stable regime.

Keywords: exchange rate regimes; macroeconomic volatility; financial crisis; exchange rate misalignment (search for similar items in EconPapers)
Date: 2008
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DOI: 10.1080/17520840802252217

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