Can the European Monetary System be a model for East Asian monetary cooperation?

Abstract

Since the 1997 Asian financial crisis and the launch of the European Economic and Monetary Union shortly afterward, a growing number of studies have considered the idea of a so-called Asian Monetary System, mostly adopting the European Monetary System as its model. The operational adjustment burdens in the European Monetary System were asymmetrically distributed, however, in particular between Germany and the other member countries. The emulation of such an asymmetric system in East Asia is not likely to be sustainable, due to the much lower support for regional integration there than was the case in Europe. For a future Asian Monetary System to be sustainable, it should be designed in such a way as to promote symmetry in the adjustment burdens arising from its operation. To this end, it may be desirable for the Asian Monetary System to employ an exchange rate and intervention mechanism that levies adjustment burdens largely on participant currencies deviating substantially from the average member currency movements. This mechanism should also be constructed in such a way that each currency's probability of identification as a deviant currency is similar.

Keywords:

• Asian currency unit
• Asian Monetary System
• East Asian monetary cooperation
• regional monetary unit

JEL classifications:

• F33
• F55

Acknowledgements

The author would like to thank Ouk-Heon Song, Young Kyung Suh, Yong Bok Kim, Michael C. Marking, Wosik Moon and seminar participants at the Bank of Korea for helpful comments. The views expressed here are those of the author only and should not be interpreted as representing the Bank of Korea or its policy.

Notes

1. See, for example, Kawai and Takagi (2000), Ogawa and Ito (2002) and Williamson (2005).

2. There are several variations of an East Asian regional currency basket proposed, with names such as the Regional Currency Unit, the Asian Currency Unit and the Asian the Monetary Unit, but the concepts behind them are all very similar to that behind the RMU.

3. See, for example, Ogawa and Shimizu (2006, 2007), Wilson (2006), Lee and Yoon (2007) and Murase (2007). In addition to the two types of common currency basket mentioned, some scholars have also recently proposed one that consists of the dollar, euro and yen plus other East Asian currencies. See, for example, Kawai (2008).

4. The ASEAN+3 is a forum for coordinating cooperation among the Association of Southeast Asian Nations (ASEAN) countries and the three Northeast Asian countries of Japan, China and South Korea. It was first created in December 1997, and then institutionalized in 1999. Its Research Group studies mid- and long-term cooperative issues.

5. See, for example, Ogawa and Shimizu (2006, 2007), Wilson (2006), Lee and Yoon (2007) and Murase (2007).

6. For a review of the related literature, see Watanabe and Ogura (2006) and Chey (2009b).

7. The nine member countries were Germany, France, the UK, the Netherlands, Italy, Belgium, Luxembourg, Denmark and Ireland.

8. Although the UK participated in the EMS from its beginning, and the pound sterling was therefore included in the ECU, it did not join the ERM until October 1990.

9. The realignment was subject to mutual agreement by all countries participating in the ERM and the European Commission (European Council 1978).

10. Therefore, if all the bilateral fluctuation margins were assumed to be ±2.25%, the maximum divergence spread for each currency would be equal to (± 2.25) × (the sum of the weights of the other ECU currencies) or could be expressed as follows: (± 2.25) × (1 - the weight of the currency) (European Commission 1979, p. 87).

11. Diversified intervention referred to intervention in a variety of currencies, rather than in only the currency that was furthest away from the intervening country's currency, and was intended to spread the burden of intervention among ERM currencies. Domestic monetary policy measures embraced those affecting interest rates that had a direct impact on capital flows, and other measures of economic policy included, for example, budgetary or incomes policy changes (van Ypersele de Strihou 1979, p. 15).

12. Without the divergence indicator system, in fact, the ERM was essentially the same as the system operated in the European ‘snake’ – the precursor to the EMS, which was heavily criticized for its asymmetric operation (Bank of England 1979, p. 190).

13. Moreover, the very short-term financing credit was denominated and partly repayable in the ECU, and a creditor country could refuse repayment in the ECU only when it surpassed 50% of the claim. This implied a real wealth transfer from the country with the appreciating currency to that whose currency was depreciating, and a sharing by the two countries of the risk of parity realignment (Fratianni and von Hagen 1992, pp. 23–26).

14. Methods that have been most frequently used in testing this hypothesis include causality tests on interest rates or monetary aggregates, investigations of intervention in foreign exchange markets, etc.

15. See, for example, Giavazzi and Giovannini (1987), Mastropasqua et al. (1988), Karfakis and Moschos (1990), MacDonald and Taylor (1990), Artus et al. (1991), Herz and Röger (1992), Kirchgässner and Wolters (1993) and Baum and Barkoulas (2006).

16. See, for example, Cohen and Wyplosz (1989), De Grauwe (1989), von Hagen and Fratianni (1990), Fratianni and von Hagen (1990b), Kutan (1991), Koedijk and Kool (1992), Katsimbris and Miller (1993), Caporale et al. (1996), Fujihara and Mougoué (1996), Kanas (1997), Hassapis et al. (1999), Bajo-Rubio et al. (2001), Camarero and Ordóñez (2001), Laopodis (2001, 2004), Bajo-Rubio and Montávez-Garcés (2002) and Booth and Ciner (2005).

17. A few studies argue that US monetary policy also had a strong influence on EMS countries’ monetary policies. See, for example, Katsimbris and Miller (1993), Hassapis et al. (1999) and Booth and Ciner (2005). However, Fratianni and von Hagen (1990a), Artus et al. (1991), Kirchgässner and Wolters (1993) and Baum and Barkoulas (2006) show that the impact of changes in US interest rates on interest rates in the EMS countries was actually quite limited.

18. There are a good number of studies showing that the degree of asymmetry in the EMS changed to some extent over time. However, the question of whether it weakened or intensified as time passed is controversial. One group, including von Hagen and Fratianni (1990), Fujihara and Mougoué (1996), Uctum (1999), Camarero and Ordóñez (2001) and Laopodis (2001, 2004), argues that the asymmetry weakened in the later EMS period. The other group, of which Biltoft and Boersch (1992) and Bajo-Rubio et al. (2001) are examples, argues the converse. Given the strong controversy on the issue, this paper will focus only on the general finding that the EMS worked asymmetrically.

19. For more evidence countering the credibility argument, see Melitz (1987, p. 18) and Fratianni and von Hagen (1992, pp. 68–71).

20. The Bundesbank publicly declared that as a matter of principle, the divergence indicator would never be a standard for its own performance and that it would always give priority to internal monetary stability over external stability (Vaubel 1980, p. 187).

21. For instance, during the first year of the EMS, the Danish krone and the DM reached their intervention points in the parity grid system several times, without coming close to their divergence thresholds (Vaubel 1980, p. 185).

22. In contrast, a much more probable case was the situation in which only two currencies approached their bilateral fluctuation margins against each other, while appreciating and depreciating by the same respective degrees from the average for the other member currencies. In this case, the two extreme currencies could reach their bilateral fluctuation margins without passing their divergence thresholds (Vaubel 1980, pp. 185–186).

23. It was only after outbreak of the ERM crisis in September 1992 that Germany carried out intramarginal intervention (Gardner and Perraudin 1992, pp. 4–5).

24. Germany increasingly accepted the use of the DM by other EMS countries for intramarginal intervention, and as a result, DM use for intramarginal intervention became prevalent (Rieke 1990, p. 30). However, Germany did so because EMS countries used their DM balances held on the Euromarkets, which had no effect on either the Bundesbanks’ liabilities or the German monetary base (Mastropasqua et al. 1988, pp. 258–259, 270).

25. According to the International Monetary Fund, the DM accounted for about 11% of identified international reserve holdings in the world in 1978.

26. Eurobarometer can be obtained at the website of the European Commission (http://ec.europa.eu/public_opinion/archives_en.htm).

27. The data are available, in Japanese, on the website of the Cabinet Office of Japan (http://www.cao.go.jp/index.html).

28. The data are available on the website of the Pew Research Center (http://pewresearch.org).

29. That Germany accepted this demand from EMS countries for more symmetric monetary cooperation was perhaps mainly due to German reunification, which had given Germany an incentive to alleviate doubts about its commitment to the European Community and multilateralism (Chang 2003, p. 225).

30. This issue becomes more complicated when the influence of the US on East Asian monetary cooperation is considered. For more on this issue, see Chey (2009a).

31. See the cited references for detailed explanations of these properties of the divergence indicator system of the EMS.

32. In consumer price index terms, the inflation rates of South Korea, Japan, China and the 10 ASEAN countries between 2000 and 2005 averaged about 5%, a much lower level than the approximately 10% in ERM countries at around the time of EMS establishment (1975–1978). The probability that the introduction of such an AMS will lead member countries to face high inflation is thus unlikely to be great.

33. The Research Institute of Economy, Trade and Industry, an important Japanese think tank, publishes the AMU deviation indicators on its web page, adopting the work of Ogawa and Shimizu (2005). These indicators show the degree of deviation from the theoretical benchmark rate for each of the East Asian currencies in terms of this AMU.

34. In 2008, the standard deviation of ASEAN+3 countries’ shares in aggregate intraregional trade was about 8.2. That of their shares in aggregate intraregional nominal GDP was about 14.1, meanwhile, and that of their shares in aggregate intraregional GDP measured at purchasing power parity about 13.8.

35. How to allocate currencies’ weights in an RMU is thus a critical issue for creation of an AMS using it. However, East Asian countries have reached no consensus on this issue and proposed different methods. In the 2006 ASEAN+3 Research Group study of an RMU, for example, the Japanese report (IIMA 2007) suggested the use of capital market openness as one standard for calculating currencies’ weights in the RMU, while the South Korean report (Moon et al. 2007) ignored capital market openness in its standard recommendations.