Conclusion

This paper leaves the policymaker with unanswered operational questions. What precisely is the right level of foreign exchange reserves for self-insurance in a world of unanchored exchange rates and volatile capital flows? Once that level of reached, what then? Allowing the exchange rate to rise has to be part of the answer, but how far? Can the International Monetary Fund’s renewed interest in exchange rate surveillance fill the gap, based on macro-balance, equilibrium REERs and sustainability calculations? Can this be linked into the supposedly deeply embedded relationships of saving and investment, using this as a basis for a view about the appropriate current account balance? If this can be used to identify the appropriate current account position, how can policy maintain capital flows at around this same size?

This paper does little more than clear the decks and set an agenda for more operationally focused research. Clearing the decks, however, seems important, as analytical thinking about these issues has been severely hampered by doctrinal blinkers. The Impossible Trinity, UIP and a strong predilection for the “magic of the market” has meant that in the decade following the Asian crisis, much of the expert advice being offered was simply not listened to. When pure floats are advocated, there is no discussion of how policy should conduct a managed float or manage foreign exchange reserve levels. When prudential rules are limited to micro balance sheet issues, larger macro implications of the behavior of the financial sector are ignored. When free capital flows are doctrinally believed to be optimal, there is no useful discussion of how countries might limit and restrain these flows. A practical research agenda would encompass the design parameters of a managed float, reserve holdings and intervention policies, including the possibility of using state-contingent assets and government foreign/domestic debt management as well as conventional reserves. It would provide an analytic framework for judging whether a current account was broadly appropriate. Finally, it would explore taxation constraints on surges of inflow (including URR), stronger (i.e., more intrusive) prudential measures, contingent controls on capital outflows, and better bankruptcy procedures, both domestically and for foreign debts.

There is no likelihood of a “twin crisis” in East Asia any time soon, as the countries of the region (whether by design or accident) have taken the narrowly conservative path of running current account surpluses and accumulating reserves. This seems neither optimal nor sustainable. With capital flowing “uphill” and foreign exchange reserves overflowing the coffers, the current conjuncture is not sustainable and increasing globalization will put further pressure on these imbalances over time. When East Asia returns to the more normal configuration of significant current account deficits, the benefits of such crisis preparedness will become apparent.

Download this Discussion Paper [ PDF 557KB| 36 pages ].

Post a Comment

We welcome your feedback on this publication. Post a comment. ADBI is not obliged to acknowledge or publish comments and may abridge or edit them before web posting.

Comment(s)

There are [0] comment(s) for this entry. Post a comment.