Regional Exchange Rate Management in East Asia: Possibilities and Limits

Abstract

East Asian countries have rich experience in the advantages and disadvantages of financial globalization. Foreign direct investment enabled the rapid economic growth of the East Asian economies through export increases while liberalization of capital controls made these countries vulnerable to the rapid outflow of foreign capital. The Asian financial crisis in the late 1990s highlighted this structural vulnerability. After the financial crisis, East Asia tried to create a regional financial safety net and became the second example of financial regionalism after Europe. Facing repeated international financial crises such as the Lehman shock and the European sovereign debt crisis, East Asian countries are now discussing its further development. This chapter analyses the driving forces of East Asian financial regionalism, and examines its possible further development. Although a common currency seems improbable in the foreseeable future, it is possible that in East Asia a group of countries will introduces a new strengthened framework to prevent excessive intraregional exchange rate volatility. The critical point for this new framework is whether the involved countries can agree on appropriate ex ante conditions to prevent moral hazards, as these require continuous limitation of an aid-receiving country’s sovereignty.