EXCHANGE RA TE REGIMES AND MACROECONOMIC STABILITY EXCHANGE RATE REGIMES AND MACROECONOMIC STABILITY edited by Lok-Sang Ho Lingnan University Hong Kong Chi-Wa Yuen University of Hong Kong Peking University and Wuhan University Hong Kong SPRINGER SCIENCE+BUSINESS MEDIA, LLC Exchange Rate Regimes and Macroeconomic Stability edited by Lok-Sang Ho and Chi-Wa Yuen ISBN 978-1-4613-5365-2 ISBN 978-1-4615-1041-3 (eBook) DOI 10.1007/978-1-4615-1041-3 Copyright@ 2003 Springer Science+Business Media New York Originally published by Kluwer Academic Publishers in 2003 Softcover reprint of the hardcover 1st edition 2003 AlI rights reserved. 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CONTENTS List of Contributors Vll F oreword Assaf Razin Xl Acknowledgments xm Chapter 1 Introduction 1 Lok-Sang Ho and Chi-Wa Yuen Part 1 The Asian Currency Crisis: Responses and Policy Options 7 Chapter 2 Lessons from the Asian Financial Crisis, and the Prospects for Resuming High Growth 9 Wing Thye Woo Chapter 3 Financial Market Stability, Monetary Policy, and the IMF 33 Joseph Stiglitz Chapter 4 The IMF Approach to the Asian Currency Crises: An Alternative View 55 Charles Adams Chapter 5 Does Asia Need a Common Currency? 61 Robert Mundell Chapter 6 Recommending a Currency Basket System for Emerging East Asia 77 Masahiro Kawai Part 2 Monetary Policy, Exchange Rate Regimes, and Macroeconomic Stability 105 Chapter 7 A Comparative Analysis ofExchange Rate Regimes 107 Naoyuki Yoshino, Sahoko Kaji and Ayako Suzuki vi Exchange Rate Regimes and Macroeconomic Stability Chapter 8 Bringing about Realistic Exchange Rates: A Post-Asian Financial Crisis Perspective 133 Lok Sang Ho Chapter 9 Contemplating the Credibility of Currency Boards 145 Corrinne Ho Chapter 10 Currency Board, Asian Financial Crisis, and the Case for Put Options 185 Francis T. Lui, Leonard K. Cheng and Yum K. Kwan Chapter 11 The Currency Board in Hong Kong: Operational Weaknesses and a Proposed Refinement Scheme 215 Alex W.H. Chan Postscript Understanding Crises 247 Chi-Wa Yuen Index 251 LIST OF CONTRIBUTORS Charles Adams is Assistant Director at the IMF's Regional Office for Asia and the Pacific. During 2000/2001, he was on a one-year leave of absence at the Asian Development Bank, where he was a senior economic advisor. He has held various positions during his nineteen-year career at the Fund including in the Research, Asia and Pacific, and Policy Development and Review departments. Alex W.H. Chan is Assistant Professor in the School of Economics and Finance of the University of Hong Kong. His research interests are the areas of derivative valuation, investments, risk management, and exchange rate systems. Leonard K. Cheng, Ph.D. (California-Berkeley), is Professor and Head ofthe Department of Economics at the Hong Kong University of Science and Technology. His research fields are international economics, foreign direct investment, market structure, and technological innovation and imitation. Corrinne Ho is an economist in the Monetary and Economic Department of the Bank for International Settlements. Prior to joining the BIS, she was a student and lecturer at Princeton University. Her fields of interest include exchange rate, monetary policy and economic institutions. Lok Sang Ho is Director of the Centre for Public Policy Studies, Lingnan University, Hong Kong and Hon. Research Fellow at the Chinese University of Hong Kong. He has been President of the Hong Kong Economic Association since 1999. His Kluwer book, Principles 01 Public Policy Practice, reflects his wide interest in a wide spectrum of policy issues. Sahoko Kaji holds a Ph.D. in economics from the Johns Hopkins University. She has been Professor of Economics at Keio since 1999. She had published in leading economic journals on international economic issues such as financial crisis and the EMU. viii Exchange Rate Regimes and Macroeconomic Stability Masahiro Kawai is Deputy Vice Minister for International Affairs at Japan's Ministry ofFinance since July 2001. He was formerly Chief Economist of the World Bank's East Asia and Pacific Region, and prior to April 1998, Professor of Economics at the Institute of Social Science of the University of Tokyo. He holds a Ph.D. in economics from Stanford University. Yum K. Kwan is Associate Professor ofEconomics at the City University of HongKong. Francis T. Lui, PhD (University of Minnesota) is Professor of Economics and Director of Center for Economic Development at the Hong Kong University of Science & Technology. His research interests include endogenous growth, population economics, social security, corruption, and exchange rate regimes. Robert Mundell is University Professor ofEconomics, Columbia University. He is the 1999 Nobel Laureate in Economic Science. Joseph E. Stiglitz is the 2001 Nobel Laureate in Economics and Professor of Economics, Business, and International Affairs at Columbia University. Ayako Suzuki received her BA in economics from Keio University in 1994. She received her MPhil in International Finance from the University of Glasgow in 1998 and is now enrolled in the doctoral programme at the Department ofEconomics at the Johns Hopkins University. Wing Thye Woo, Professor of Economics, University of California, Davis, specialises in open-economy macroeconomics, and economic growth, and has expertise in the economies of China, India, Indonesia, Iran, Korea, Malaysia, Mongolia, Taiwan, and Vietnam. He is also the Director of the East Asia Pro gram of the Earth Institute at Columbia University. Naoyuki Y oshino holds a Ph.D. in economics from Johns Hopkins University. He had been Assistant Professor at the State University of New Y ork at Buffalo and Visiting Scholar at the Massachusetts Institute of Technology. He is now Professor of Economics at Keio University. He coauthored with Thomas Cargill a book The Postal Saving System and the Fiscal Investment and Loan Program in Japan (Oxford University Press, 2002). List ofContributors ix Chi-Wa Yuen, a Chicago PhD and a macroeconomist, is currently teaching at the University of Hong Kong, Peking University, and Wuhan University. With Jacob Frenkel and Assaf Razin, he is co-author of Fiscal Policies and Growth in the World Economy, a popular graduate text in open-economy macro. FOREWORD The Asian crisis of 1997-1998 could be viewed as a watershed in our macroeconomic thinking concerning exchange rate regimes, the functioning of il).ternational institutions, such as the IMF and the World Bank, and international contagion of macroeconomic instability from one country to another. In the now famous annual meeting ofthe IMF and the World Bank held in Hong Kong in September 1997, shortly after the outbreak of the Asian crisis, officials of the international institutions pushed for the deregulation of capital flows, as an obligation of any member of the IMF. This position, seemingly a bureaucratic inertia, was in disregard to the nature of the balance of payments problems that the country could be subject to, or the soundness and credibility of its financial institutions. Old issues were subject to renewed inteHectual scrutiny. Should crisis-stricken countries raise interest rates? On the one hand, raising interest rates could restore monetary balance by strengthening domestic currency. On the other hand, by raising the interest rate the central bank places pressures on financial intermediaries and firms with heavy loads of short-term debt and thus can weaken the exchange rate. This fine book offers perspectives on this debate from the viewpoints of two Nobellaureates, an IMF economist, and Asian economists. It contains a selection of papers, mostly chosen from the bi-annual meetings of the Hong Kong Economic Association that took place in December 2000. It contributes interesting new ideas to the ongoing inteHectual debate on the role of domestic monetary authorities and international institutions in reducing the likelihood of international financial crises, as weH as the problems associated with various exchange rate regimes from the standpoint of macroeconomic stability. AssafRazin Tel Aviv University and Cornell University ACKNOWLEDGMENTS The editors and the Hong Kong Economic Association acknowledge with thanks the support from the Hong Kong Institute for Monetary Research, the Bank of East Asia, and the Asian Development Bank in making the First Biennial Conference of the Hong Kong Economic Association possible. Most of the articles included in this volume were first presented in that Conference. We also thank Blackwell Publishers for permission to reproduce articles by Stiglitz and by Mundell earlier published in Pacific Economic Review, and Palgrave for permission to include an article by Lok Sang Ho largely adapted from a chapter first published in Twenty First Century W orld Order and the Asia Pacific, edited by James C. Hsiung.