Conclusion

The impacts of the US monetary shocks on East Asian exchange rates and domestic interest rates are different depending on the exchange rate regimes. The conventional theory suggests that in the floating exchange rate regime the expenditure-switching effect is the main channel so that expansionary monetary policy in the US increases the real output of the US while decreasing the real output in other countries. This would occur through exchange rate channel in the world of floaters. However, the conventional theory suggests that in the case of a fixed exchange rate regime, expansionary US monetary policy induces increases in real output of other countries as other countries increase their interest rates at the expense of independent monetary policy.

However, the conventional wisdom reverses in Asia. This paper shows that that the conventional exchange rate channel is unlikely to play much role in the transmission of the U.S. monetary policy shocks to floaters in East Asian countries, excluding Japan. These countries turn out to change domestic interest rate strongly to offset the US interest rate changes by giving up monetary autonomy, probably as a result of fear of floating. On the other hand, in the countries with capital account restrictions and fixed exchange rate regime, such as the PRC and Malaysia, neither channel is likely to play any role in the transmission of the US monetary policy shocks. They enjoy independent monetary policy probably with the help of capital account restrictions.

This finding is relevant not only for identifying the international monetary transmission mechanism in Asia, but also for predicting the rebalancing processes from the global financial crisis and global imbalances. The prolonged expansionary monetary policy in the US will help in Asia, especially for floaters. In the case of floaters, domestic demand and output would increase without the expenditure-switching effects responses to US expansionary monetary shocks. Moreover, non-floaters may enjoy more room for maneuvering domestic interest rates due to lower interest rates in the US. On the other hand, a contradiction persists on the issue of foreign exchange reserves that is quite related to the issue of rebalancing. If Asia has been successful in mitigating the external shocks by holding huge amount of foreign reserves, then Asia will continue to accumulate the foreign reserves regardless of exchange rate regimes. This will not reduce the global imbalances that might be a partial cause of the global crisis in 2008, and furthermore will not facilitate the appropriate rebalancing process.

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