The Mexican and East Asian currency crises and their sequels in Russia, Brazil, Turkey and Argentina reminded us that an exchange rate regime lacking transparency and credibility could induce abrupt interruptions of short-term capital flows, subsequently leading to costly output loss, social dislocation, and frequently political turmoil. One widely shared view is that soft-peg exchange rate regimes are extremely vulnerable and inherently crisis-prone in a world of volatile capital movements. Consequently, a number of relatively fixed rate countries in East Asia were encouraged to adopt floating rate regimes for their own good as well as the broader good of the international community. An underlying notion of this argument is that a more flexible exchange rate regime leads to an awareness of risk exposures related to exchange rate fluctuations on the part of both investors and borrowers, while a pegged exchange rate regime offers an implicit guarantee to creditors that leads to moral hazard and financial vulnerability. (The rest is omitted.)

Executive Summary

I. Introduction

II. The Benefits and Costs of Currency Union
1. The “Pluses”
1) Saving Transaction Costs
2) Eliminating Exchange Rate Variability and Risks
3) Enhancing Price Stability
2. The “Minuses”
1) Loss of Sovereignty, Independent Monetary Policy, and the Lender of Last Resort
2) Loss of Seigniorage

III. Optimum Currency Area: Theory and Evidence
1. Optimum Currency Area Criteria
2. The Endogeneity of the Optimum Currency Area Criteria
3. Is Europe an Optimum Currency Area?
4. Is East Asia an Optimum Currency Area?

IV. Various Options for Regional Exchange Rate Stability in East Asia
1. U.S. Dollar Standard
2. Yen Bloc
3. Currency Basket Peg System

V. Concluding Remarks

References