Exchange Rate and ReserveManagement Policy Issue

Asian economies entered the onset of the crisis with considerable diversity in exchange rate arrangements. Some currencies (such as the Korean won and the Indonesian rupiah) were floating with considerable flexibility, while others remained tightly managed. With the crisis, those two flexible currencies depreciated sharply, while the PRC and Singapore terminated the policy of allowing their currencies to appreciate gradually against the US dollar (Figure 4 [ PDF 268.3KB | 1 page ]). Viet Nam, in late 2008, devalued the dong and widened the trading band against the US dollar. As most other currencies also softened against the US dollar, these developments meant that the Japanese yen, which remained flexible, became the only currency that appreciated against the US dollar, in part reflecting the unwinding of the yen carry-trade and greatly reduced interest rate differentials favoring other major currencies. In an environment where most Asian economies, especially Korea, benefited from currency depreciation in weathering the negative impact of the global crisis, Japan had to assume more than its share of the adjustment burden.

The propensity of most Asian economies to manage exchange rates, especially when their currencies were under appreciation pressure, meant that they accumulated large balances of foreign exchange reserves. The accumulation of foreign exchange reserves not only was an insurance against a sudden reversal of capital inflows but may also have allowed these countries to achieve some degree of monetary independence and exchange rate stability while they moved toward greater capital account openness (Aizenman, Chinn, and Ito 2009; Kim and Yang 2009). Reserve accumulation may have thus served useful purposes from the point of view of individual countries. From a more global standpoint, however, the outcome was costly. It allowed large US current account deficits to be financed at low cost and contributed to the global imbalance, the unwinding of which was in part a triggering cause of the global financial crisis. These considerations suggest that the choice of exchange rate policy by one economy could have regional and global implications, making it a subject for useful cooperative discussion.

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