Distinguished Speaker Seminar by Max Corden - Exchange Rate Regimes in Asia

W. Max Corden, Professorial Fellow in the Department of Economics of the University of Melbourne and Emeritus Professor of International Economics of Johns Hopkins University, shared his insights on exchange rate policies in East Asia at ADBI’s third Distinguished Speaker Seminar Series. Professor Corden’s lecture focused on two issues: a) the role of exchange rate regimes in the Asian financial crisis of 1997-1998; and b) the implications of allowing the renminbi (RNB) to float.

Exchange rate regimes and the Asian financial crisis. Reflecting on the role of exchange rate regimes in the Asian financial crisis, Professor Corden shared the following conclusions:

• Although fixed-but-adjustable exchange rate regimes (FBARs) figured prominently in the financial crisis, FBARs were not a major cause of the crisis. “Even if all of the countries had floating exchange rates, there still would have been some kind of crisis… because there were fundamental factors at work independent of the exchange rate regime,” Professor Corden said. At the heart of the crisis was an investment boom fuelled by irrational exuberance. Deteriorating fundamentals resulting from this boom would have set off a crisis regardless of the exchange rate regime.
  
• While a floating exchange rate regime would not have prevented a financial crisis, it could have made the adjustment process less painful, and the resulting recessions less deep. Floating exchange rates may have:
  a) prevented massive losses in foreign reserves;
  b) stemmed excessive capital inflows into unsafe investments; and
  c) encouraged hedging among borrowers who acquired short-term, foreign-denominated debt. However, Professor Corden also pointed out certain trade-offs and limitations. For instance, while floating exchange rates may have discouraged “bad” investments, it could have also discouraged “good” investments such as FDI, which are less volatile and more beneficial to the economy.
  
• For the region as a whole, unhedged foreign borrowing was an important factor in the depth and severity of the financial crisis, but it was not at the heart of the crisis. Professor Corden cited the case of Malaysia, where volatile portfolio investments played a bigger role in the crisis than foreign borrowing, due to foreign exchange restrictions existing at the time.
  
• Building up significant foreign exchange reserves will only be helpful in the event of a liquidity crisis. For a solvency crisis caused by deteriorating fundamentals, more liquidity would only postpone or moderate the crisis. “More liquidity is not sufficient to actually avoid a more fundamental crisis caused by earlier irrational exuberance by the people who poured in investments in the country,” Professor Corden stressed.

Exchange rate regime for the People’s Republic of China (PRC)

Professor Corden discussed the trade-offs that would be involved if PRC were to give in to US pressure to float its exchange rate and allow the RMB to appreciate. He emphasized that such a shift would create both gainers and losers not only in PRC but in the US as well. “The dollar would depreciate relative to the RMB, so exporters will benefit. When interest rates rise, people who have put their money in fixed interest instruments will benefit. But others will lose. The people who will lose most of all are future American taxpayers, because US debt will go up due to higher interest rates,” he explained. He therefore stressed the importance of assessing the net benefits to both countries before such a policy shift is undertaken. Finally, Professor Corden noted that shifting to a more flexible exchange rate would not make much difference, if PRC chooses to manipulate the exchange rate through monetary and fiscal policy to maintain internal balance.