Hwee Kwan Chow

A common currency peg in East Asia? Perspectives from Western Europe

Abstract In this paper we investigate the feasibility of a common currency peg in East Asia from the perspective of Western European countries. We find that domestic outputs of East Asian countries are strongly influenced by country-specific shocks while regional shocks are far more important in European countries that have joined the Economic and Monetary Union. The results are robust to various changes in specifications of the model. They suggest that East Asian countries are structurally different from each other and thus more likely to be subject to asymmetric shocks. Based on optimum currency area grounds, a common currency peg in East Asia would be more costly and difficult to sustain.

Managing Capital Flows: The Case of Singapore

The resurgence of private capital inflows into Asia in recent years has raised the question of whether the region is susceptible to yet another financial crisis. While a sudden large-scale reversal of capital flows is not likely to result in a liquidity crunch or balance of payments crisis, the attendant sharp corrections in asset prices will have an adverse impact on the economy particularly through indirect channels. We present, in this study, Singapore’s experience in managing the risks posed by capital flows as well as the retention of control over exchange rates and monetary conditions. It is the overall package of policies - including strong economic fundamentals and a robust financial system, prudent policy management on both the fiscal and monetary side, and credible exchange rate policy aligned with underlying fundamentals - and having the latitude to react promptly and on a sufficiently large scale to economic and financial developments that serve to increase Singapore’s resilience towards disruptive swings in capital flows.

MONETARY POLICY AND ASSET PRICES IN A SMALL OPEN ECONOMY: A FACTOR-AUGMENTED VAR ANALYSIS FOR SINGAPORE

The ongoing global financial turmoil has revived the question of whether central bankers ought to tighten monetary policy pre-emptively in order to head off asset price misalignments before a sudden crash triggers financial instability. This study explores the issue of the appropriate monetary policy response to asset price swings in the small open economy of Singapore. Empirical analysis of monetary policy based on standard vector autoregression (VAR) models, unfortunately, is often hindered by the use of sparse information sets. To better reflect the extensive information monitored by Singapores central bank, including global economic indicators, we augment a monetary vector autoregression (VAR) model with common factors extracted from a large panel dataset spanning 122 economic time series and the period 1980q1–2008q2. The resulting FAVAR model is used to assess the impact of monetary policy shocks on residential property and stock prices. Impulse response functions and variance decompositions suggest that monetary policy can potentially be used to lean against asset price booms in Singapore.

Towards an Expanded Role for Asian Currencies: Issues and Prospects

Notwithstanding incumbency advantages and network effects enjoyed by the United States (US) dollar, considerations about the stability of its value have led Asian countries to fear they are holding their foreign exchange reserves in a depreciating currency. At the same time, it pays for the regional countries to adjust their reserve currency composition to match the point of reference of their exchange rate policy. This paper examines empirically which regional currency or currencies seem to matter for exchange rate determination in Asia beyond the very short term. To this end, we employ country-specific Vector Autoregressive (VAR) models to compare the relative impact which fluctuations in the Asian Currency Unit (ACU), yuan and yen separately have on movements of Asian currencies. Contrary to recent evidence based on daily data, we found monthly exchange rates variations in the region are more heavily influenced by the cumulative effect of key Asian currencies than by the yuan or the yen individually within the sample period we used. To the extent that exchange rates in the region shift over time from benchmarking the US dollar towards a broad range of Asian currencies, Asian central banks will find it more attractive to cross-hold Asian bonds. This calls for the development of deep private markets in such assets, as well as institutional prerequisites for internationalizing key regional currencies.

Singapore's Exchange Rate Policy: Some Implementation Issues

Reflecting the small open nature of its economy, Singapore has adopted an exchange rate-centered monetary policy framework since 1981. The exchange rate regime in Singapore is an intermediate regime that follows the basket-band-crawl system. With this managed float system, the MAS has successfully deterred speculators from attacking the domestic currency for most of the past three decades. At the same time, the flexibility accorded by the managed float system aided Singapore in escaping from the 1997–1998 Asian crisis relatively unscathed. In order to advance our understanding of the hitherto successful operation of Singapores exchange rate policy, we examine the following three aspects of its implementation: (i) the use of the exchange rate instead of the interest rate as the key monetary policy instrument; (ii) the management of the currency basket in terms of foreign exchange intervention operations; and (iii) regulating the level of domestic liquidity alongside exchange rate policy. This paper also provides some insights on the challenges ahead that potentially face policymakers when implementing Singapores exchange rate policy.

Monetary Policy Cooperation to Support Asian Economic Integration

This paper considers the form of monetary policy coordination and regional exchange rate arrangement that would best support economic and financial integration in East Asia. In view of the regions economic diversity, we propose a graduated program of informal policy cooperation from weak forms of cooperation to more intensive modes of cooperation such as the adoption of common monetary policy objectives. An array of informal monetary arrangements rooted to the degree of institutional development can improve the effectiveness of both sovereign and regional institutions, and promote integration in East Asia. Drawing upon the European experience with the Exchange Rate Mechanism (ERM), we conclude that East Asia should first embark on other forms of integration to aid in the development of a high degree of real and nominal convergence amongst the regional countries. Only then would an ERM-type system that employs a regional monetary unit become more sustainable and less susceptible to speculative currency attacks in the region.

Monetary Policy Cooperation to Support Asian Economics Integration

This paper considers the form of monetary policy coordination and regional exchange rate arrangement that would best support economic and financial integration in East Asia. In view of the regions economic diversity, we propose a graduated program of informal policy cooperation from weak forms of cooperation to more intensive modes of cooperation such as the adoption of common monetary policy objectives. An array of informal monetary arrangements rooted to the degree of institutional development can improve the effectiveness of both sovereign and regional institutions, and promote integration in East Asia. Drawing upon the European experience with the Exchange Rate Mechanism (ERM), we conclude that East Asia should first embark on other forms of integration to aid in the development of a high degree of real and nominal convergence amongst the regional countries. Only then would an ERM-type system that employs a regional monetary unit become more sustainable and less susceptible to speculative currency attacks in the region.

Forecasting Inflation With A Financial Conditions Index: The Case Of Singapore

This paper explores whether a financial conditions index (FCI) can serve as a good predictor of inflation and hence, a useful guide to monetary policy in the context of Singapore by constructing an index that comprises interest rates, exchange rates, credit expansions, stock prices and house prices. The choice of these variables is motivated by the role they play in the monetary transmission mechanism and how they contribute to inflationary pressures in an economy. A weighted-sum approach is adopted for index construction whereby the weight assigned to each component is derived from the generalized impulse responses of a monetary VAR model estimated using quarterly data. Cross-correlations and Granger causality tests confirm the proposed index possesses good in-sample leading qualities over consumer price inflation. Using this index to generate predictions recursively from a direct multistep forecasting methodology yields substantial gains in out-of-sample prediction performance when compared with forecasts of a benchmark autoregressive model for inflation within the one-year forecast horizon.

Optimum Currency Area in Europe: An Alternative Evaluation

Abstract In this paper we explore an alternative scheme to assess the suitability of adopting a common currency by Western European countries. It is based on the role of common regional shocks in the determination of output. The results show that the OCA theory well explains and predicts participation decisions in EMU. We also find that our OCA index is highly consistent with two popular schemes that have been introduced by Bayoumi and Eichengreen [in: F. Torres, F. Giavazzi (Eds.), Shocking Aspects of European Monetary Integration. in Adjustment and Growth in the European Monetary Union , Cambridge University Press, Cambridge (1993); European Economic Review 41 (1997) 761–770].