Edited by Koichi Hamada, Beate Reszat and Ulrich Volz
Chapter 7: Current Account Surpluses and Conflicted Virtue in East Asia: China and Japan under the Dollar Standard
Ronald McKinnon and Gunther Schnabl1 INTRODUCTION 7.1 The 1997–98 Asian crisis triggered a still ongoing debate about what the proper exchange rate policy should be in East Asia. Before 1997, all the East Asian countries—with the important exception of Japan—informally pegged to the dollar at both high and low frequencies of observation. But opinions diverge as to whether this soft dollar pegging aggravated the crisis. The International Monetary Fund’s (IMF) position is that these soft dollar pegs accentuated moral hazard in poorly regulated domestic banks (Fischer 2001). In the absence of immediate foreign exchange risk, they over-borrowed by accepting foreign currency deposits at lower interest rates in order to make higher-yield loans in their domestic currencies. However, floating the exchange rate may not be the correct policy response for curbing moral hazard in banks. McKinnon and Pill (1999) suggest that the differential between domestic and foreign interest rates might actually widen under a volatile float, thus aggravating the temptation to over-borrow. While the academic discussion about the pros and cons of more exchange rate flexibility continues, the focus of the political discussion about the proper exchange rate regimes in East Asia has shifted toward the pros and cons of allowing appreciations of the East Asian currencies against the dollar. Some authors have argued—in particular with respect to China—that countries in the economic catch-up process that are running high saving surpluses should allow their exchange rates to appreciate to curtail “excessive” surpluses in their current accounts...
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