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By providing a comprehensive overview of policy proposals for the international monetary system from an Asian perspective, this book aims to identify what innovations are needed to reform the international monetary and financial system to promote financial stability and sustainable economic growth for emerging economies. The book is organized into four parts. Part 1 discusses major theoretical and empirical issues related to reform of the international monetary system. Part 2 includes two chapters that present the recent developments and challenges for managing capital flows. Part 3 presents different perspectives on regional currency cooperation in Asia and Europe by assessing the evidence supporting increased currency coordination in Asia and by review issues of policy cooperation in the Euro area after the global financial crisis and their implications for Asia. Part 4 discusses emerging issues for regional/global cooperation and financial safety nets. The main inference of the book is that, in light of the drawbacks of the existing international monetary system exposed in the global financial crisis, along with other countries, Asian emerging economies should work cooperatively to reform and strengthen international monetary and financial policy. To do so, regional and global monetary cooperation is needed and financial safety nets should be strengthened to alleviate the impact of possible global financial crises. This will be one of the first books written about the global financial crisis and the on going the European sovereign debt crisis to comprehensively address the issues related to currency cooperation, based on the Euro area experience, with the specific implications for Asia.



Chapter 1. Reform of the International Monetary System: Introduction and Overview

This chapter provides an overview of the issues related to reform of the international monetary system in light of experiences during the global financial crisis of 2007–2009 and related developments, particularly the eurozone sovereign debt and banking crisis, with a focus on the implications for Asian economies. Contributions by various international experts are presented focusing on topics covering policy reforms on how to develop balanced policy frameworks that support currency stability, monetary policy independence, and an increasing degree of financial openness, and how to build robust, resilient financial systems that can serve the interests of the real sector in a stable manner and absorb shocks coming from volatile capital flows and global financial turmoil. The thematic topic areas covered include (i) international monetary system reforms, (ii) managing international capital flows, (iii) Asian currency arrangements, (iv) regional financial cooperation, and (v) linking regional and global initiatives.
Masahiro Kawai, Peter J. Morgan

International Monetary System Reforms


Chapter 2. International Monetary Reform: A Critical Appraisal of Some Proposals

This chapter reviews some of the current debates on the reform of the international monetary system. Despite its deficiencies, the United States (US) dollar will remain the dominant currency and special drawing rights (SDR) cannot serve as either an international medium of exchange or a reserve currency. The International Monetary Fund (IMF) has changed its position to accept capital controls under certain circumstances. Refining control instruments better tuned to present day markets may bring about greater acceptance. The 2008–2009 global financial crisis has dimmed much of the earlier hope for the multilateralized Chiang Mai Initiative. The currency swap arrangements portend a new form of international cooperation. Finally, for the Group of Twenty (G20) to matter, the systemically important countries need to ensure the stability of their financial systems and economies.
Yung Chul Park, Charles Wyplosz

Managing International Capital Flows


Chapter 3. Rethinking Capital Flows for Emerging East Asia

Since the 1980s, emerging countries have been urged to welcome foreign capital inflows. The result has often been a pattern of surges where excessive inflows were followed by damaging “sudden stops” and reversals. This was dramatically evident in the Asian financial crisis of 1997–1998. Since that crisis, the emerging countries of East Asia have typically run current account surpluses and have accumulated substantial foreign exchange reserves. This has kept them largely protected from the impact of volatile capital flows, but this strategy is neither sustainable nor optimal.
What is needed is a strategy that makes use of the potential benefits of capital “flowing downhill” (that would require these countries to run current account deficits) while at the same time protecting them from both the excessive inflows and the reversals. This strategy needs to take account not only of the fickle nature of the capital flows, but the structurally-higher profitability which is characteristic of emerging countries, which motivates the excessive inflows. This strategy would require more active management of both exchange rates and capital flows than has been the accepted “best practice”, this requires a substantial shift in the current policy mindset. The International Monetary Fund has shifted some distance on this issue, but has further to go.
Stephen Grenville

Chapter 4. New Measures of the Trilemma Hypothesis: Implications for Asia

We develop a new set of indexes of exchange rate stability, monetary policy independence, and financial market openness as the metrics for the trilemma hypothesis. In our exploration, we take a different and more nuanced approach than the previous indexes developed by Aizenman et al. We show that the new indexes add up to the value two, supporting the trilemma hypothesis. We locate our sample economies’ policy mixes in the famous trilemma triangle—a useful and intuitive way to illustrate the state and evolution of policy mixes. We also examine if the persistent deviation of the sum of the three indexes from the value two indicates an unsustainable policy mix and therefore needs to be corrected by economic disruptions such as economic and financial crises. We obtain several findings. First, such a persistent deviation can occur particularly in emerging economies that later experience an inflation (or potentially a general or a currency) crisis, and dissipates in the postcrisis period. Second, there is no evidence for this type of association between deviations from the trilemma constraint and general, banking, or debt crises. Third, Thailand experienced such a deviation from the trilemma constraint in the period leading to the baht crisis of 1997, but not other East and Southeast Asian economies. This last result suggests that the main cause for the Thai baht crisis was an unsustainable policy mix in the precrisis period, while other affected economies experienced crises mainly due to contagion from Thailand.
Hiro Ito, Masahiro Kawai

Asian Currency Arrangements


Chapter 5. Revisiting the Internationalization of the Yuan

As the world’s second largest economy, largest trading nation, and the largest foreign holder of United States (US) government bonds, the People’s Republic of China (PRC) needs a currency with international status that can match its economic status in the global economy. However, sequencing is important. Before the internationalization of the yuan can make meaningful progress, necessary conditions, such as the existence of deep and liquid financial markets, a flexible exchange rate and interest rates responsive to market conditions must be created.
The process of yuan internationalization essentially is a process of capital account liberalization. Due to the unprecedented and complex global financial crisis and the PRC’s huge imbalances, capital account liberalization has to be pursued in a cautious way. As a result, the internationalization of the yuan is bound to be a long-drawn process.
The PRC’s road map for the internationalization of the yuan is flawed with many missing links and wishful thinking. Yuan internationalization guided by the current road map may prove to be counterproductive.
Yongding Yu

Chapter 6. Exchange Rate Coordination in Asia: Evidence Using an Asian Currency Unit

This chapter evaluates the extent of exchange rate coordination among Asian economies using a hypothetical Asian currency unit. Rising interdependence among Asian economies makes it vital for these economies to have a certain degree of exchange rate stability. However, the empirical evidence using an Asian currency unit suggests a widening deviation in exchange rate movements of the Asian currencies. The deviation has been driven by the adoption of different exchange rate regimes by the participating countries indicating diverse policy objectives. There are a number of institutions in the region that can assist exchange rate coordination and greater economic and financial integration. These institutions, including a multilateralized swap arrangement, a regional surveillance mechanism, and a bond fund; have to be significantly strengthened for them to play a role in fostering greater economic cooperation. The denomination of financial assets in the Asian currency unit in transactions involving these institutions would also enhance exchange rate cooperation.
Abhijit Sen Gupta

Regional Financial Cooperation


Chapter 7. Europe’s Crisis, Coordination Failure, and International Effects

This chapter gives an overview of the causes of the European crisis and the consequences for external relations. The euro crisis was triggered by a policy shock in Greece, but occurred on the background of a financial system that had been destabilized by the global financial crisis earlier. Two alternative models are frequently used to explain the crisis: irresponsible fiscal policies by autonomous member states and financial instability that paralyzes the banking system. The chapter finds little evidence for excessive public borrowing and unsustainable public debt. By contrast, the financial crisis in 2008–2009 after the Lehman Brothers’ bankruptcy has weakened the balance sheets of banks and the new sovereign debt shock has re-enforced liquidity concerns. Collective action problems and political mishandling by member states have further increased uncertainty, which has spilled over into the real economy. The loss of confidence in European capacity to handle the crisis has contributed to a tendency for the euro to become weaker. Thus, Europe’s debt crisis is in reality a political crisis. Either Europe will move forward and deepen its political integration, or it will disappear as a global player and sink into irrelevance.
Stefan Collignon

Chapter 8. Prevention and Resolution of Foreign Exchange Crises in East Asia

This chapter discusses mechanisms to prevent and resolve foreign exchange crises in East Asia. Policies and mechanisms at the country level as well as regional and global levels are discussed. Policies at the level of a particular country to prevent foreign exchange crises include the management of short-term foreign currency liabilities, the adequacy of reserves, and managing episodes of rapid short-term capital inflows. The author discusses the development of regional mechanisms for crisis prevention and resolution in conjunction with the global mechanisms, including the Chiang Mai Initiative (CMI) and the Chiang Mai Initiative Multilateralization (CMIM). The author then suggests how the CMIM can evolve into an integrated crisis prevention and resolution mechanism for East Asia.
Chalongphob Sussangkarn

Linking Regional and Global Initiatives


Chapter 9. Regional and Global Monetary Cooperation

The increasing occurrence of national, regional, and global financial crises, together with their rising costs and complexity, have increased calls for greater regional and global monetary cooperation. This is particularly necessary in light of volatile capital flow movements that can quickly transmit crisis developments in individual countries to other countries around the world. Global financial safety nets (GFSNs) are one important area for monetary cooperation. This chapter reviews the current situation of regional and global monetary cooperation, focusing on financial safety nets, with a view toward developing recommendations for more effective cooperation, especially between the International Monetary Fund (IMF) and regional financial arrangements (RFAs).
A GFSN should have adequate resources to deal with multiple crises, should be capable of rapid and flexible response, and should not be encumbered by historical impediments such as the IMF stigma that would limit its acceptance by recipient countries. Oversight of a GFSN needs to be based on cooperation between global and regional forums, for example, the Group of Twenty (G20) and the Association of Southeast Asian Nations (ASEAN)+3 or East Asia Summit (EAS). Such a GFSN should include the IMF and RFAs at a minimum, and it is highly recommended to find ways to include central banks as providers of swap lines and multilateral banks as well. The basic principles governing the cooperation of IMF and RFAs include rigorous and even-handed surveillance; respect of independence and decision-making processes of each institution and regional specificities; ongoing collaboration as a way to build regional capacity for crisis prevention; open sharing of information and joint missions where necessary; specialization based on comparative advantage; consistency of lending conditions and conditionality, although with flexibility; respect of the IMF as preferred creditor; subsidiarity; avoidance of moral hazard; and transparency.
Mario B. Lamberte, Peter J. Morgan


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