Fiscal Policy and Economic Growth - Essay Example

? Fiscal Policy and Economic Growth Macro & Micro economics 1 Introduction The purpose of this assignment is to analyze macroeconomics basic concepts. This assignment is a review of an existing article titled EXCHANGE RATE REGIME TRANSITION DYNAMICS IN SOUTHEAST ASIA by Monzur Hossain. This paper has investigated the currency regime choices of six Southeast Asian Countries. These countries include Indonesia, Korea, Malaysia, Philippines, Singapore, and Thailand. These countries have been examined for the period of 1973 – 99. The dynamics of regime transition are insignificant among a variety of regimes including fixed, intermediate, and floating regimes. 1.2 Models and concepts This article is analyzed on the basis of managed floating regime rather than currency exchange system i.e. all models have been included in the analysis in a floating diagram in order to support the floating regime of exchange among the countries. Multi-state markov have also used to study the article in authors perspective. It works on the basis of continuous time frame and studies the duration of regime. Financial liberalization indicator is used in graphical representation to identify the development of various sectors. 1.3. Analysis In the exchange rate regime, the main focus is the Southeast Asian crisis in 1997 – 78. Before the Southeast Asian crisis in 1997 – 98, the economies of these countries had adopted diverse exchange rate regimes. When the crisis was about to happen, several SEA countries had adopted floating regime by abandoning the intermediate regimes. However, Malaysia had adopted a fixed regime. Before the 1997 crisis, exchange rate was highly rigid. It had high mobility which is supposed to be one of the most important reasons for the Southeast Asia. According to the proponents of the bipolar view, countries exposed to large capital flows must avoid intermediate regimes. It is also necessary to adopt a corner regime. According to these proponents, corner regimes sustainable regimes for long run. It has been found that SEA countries also shifted from an intermediate regime to intermediate regime. A vast literature has been dedicated to found out the preferred choice of exchange rate regime. The fundamentals identified by the OCA approach has given some guidance for observed regime choices. In 1980s, studies were focused on the role of shocks on the choice of regimes. This research incorporates considerations for macroeconomic stabilization. Authors have argued that nominal shocks actually raise the possibility of a fixed regime. The real shocks allow flexibility and symmetry of shocks produces OCA. Shocks have been appeared in countries which have weak financial institutions. The counties with weak financial institutions intervene in the market in order to shield banking industries which are confronting large exchange rate movements. There are many authors who agree SEA countries should adopt a currency basket system in order to gain and maintain exchange rate stability and flexibility. As far as the macroeconomics situations of SEA countries are concerned, the most reasonable choice is managed floating regime. It is because managed floating regime is fewer complexes than currency basket system agree that managed floating regime would be less complex than the currency basket (Hossain, M. 2011). Financial liberalization index Figure 1 A cross-country index indicating financial liberalization has been used to identify the development in the sector. It ranges between 0 and 18 (Abiad, 2005). This index is made during the period or 1973 to 1995 (Figure 1 and 2). First figure studies three initial countries i.e. Indonesia, Korea and Malaysia. For the last three years FLI is assumed to be constant. These both graphs indicate the exchange rate regime in six countries. The figure indicates that till 1977 all three countries were focusing on fixed regime but due changing conditions in 1979 Indonesia and Korea shifted to intermediate regime. While Malaysia remained consistent to fixed regime. 1993 onwards all three countries started development on the basis of intermediate regime. Figure 2 Both these charts shows the fluctuations i.e. changes in regime in all six countries during the studies the performance of Thailand, Singapore and Philippines in FLI format. It shows a positive correlation of financial integration and benefits from the outcome of regime. Till 1982 Singapore and Philippines used fixed regime. While Thailand consistently used floating regime throughout the period. It was noted that Philippines also adopted fixed regime throughout the period except in 1984 when only for a year it moved to intermediate regime. While after 1983 Singapore remained constant to intermediate regime because of changing economic conditions. Historically SEA countries had maintained diverse of intermediate exchange rate regimes. It has also been found according to various reports of the Annual Report on Exchange Arrangements and Exchange. Until 1997, Indonesia‘s Rupiah was legitimately hooked to a basket of unrevealed currencies, but actually and effectively, it was a packed peg to the US dollar. It was a premium that was constantly below 20 percent and was routinely in single digits (Hossain, M. 2011). Korea followed crawling peg with less than +/- 1 percent band until 1994. After this, the band width was widened to around +/- 2 percent. The exchange rate of Singapore was pegged to the US dollar until 1990. After this, it adopted a basket of currencies with a band width of +/- 2 percent (Hossain, M. 2011). The official exchange rate regime in Malaysia before crisis was a basket with a band width of +/- 2 percent. On actual, it was a poignant band around the US dollar. The official exchange rate of Philippines official exchange rate regime was floating. However, its actual exchange rate was managed floating. However, just before the crisis currency was again pegged to the US dollar. The other five economies adopted a liberally balanced administration. It has been found that after the crisis, most of the floaters reverted to an actual intermediate regime which was more meticulous to a managed floating Regime. It was done in order to attain diverse objectives including stabilization of high-frequency exchange rate movement slow down the pace of real appreciation after the overshooting associated with the crisis, and accumulation of a war chest of international reserves. All these have been identified as reasonable objectives of the post-crisis exchange rate policy. When evaluating the factual effective exchange rate movements, it was found that stabilization of the REER can be achieved by maintaining a managed floating regime with discretionary adjustments for inflation differentials. The steadiness of nominal exchange rate is also compulsory to beat the likelihood of harsh currency problems in the balance sheets of domestic economic agents. Problems including mismatches can increase the costs associated with large exchange rate movements which has been termed by some researchers as original sin. According to some economists, adopting a basket of G3 i.e. the yen, dollar and the euro with appropriate weights could help SEA countries attain steadiness According to different authors, this understanding can make certain suppleness of exchange rates by decreasing asymmetric response to dollar depreciation. It can also prevent Southeast Asian economies from future crises. In this regard, the selection of appropriate weights to each currency is not straightforward commission. Furthermore, diverse characteristics of weights may place a currency basket in danger. On the other hand it has been argued that the pre-crisis exchange rates in crisis-hit Southeast Asian countries were not seriously overvalued that might have caused the crisis. It has also been found that common currency basket will not bring as much stability as others suggest. Researchers have argued that crisis that hit Southeast Asian countries have returned to the dollar peg in the post-crisis period. It implies that only dollar pegging can bring more stability. It is because foreign trade in these countries is mainly invoiced in the U.S. dollars. In addition these opinions, a number of observers and policy makers are concerned about the possibility of a monetary union in this region (Hossain, M. 2011). 1.4 Conclusion Thailand had maintained a basket of currencies ahead of the crisis in 1997/98. Prior to the floating exchange rate in late 1984, the Philippine peso was doweled to the US dollar. Malaysia had adopted single currency dollar pegged regime. All studies defend the policy of accumulating a large stock of international reserves. The stock of international reserves by SEA countries would work as a cushion against any future crisis. In a nut shell, the transition of currency regimes in Southeast Asian countries has implied a bias towards intermediate regime or monetary standard. According to these findings, one exchange rate can hold sway across Southeast Asia (Hossain, M. 2011). References Hossain, M. (2011). Exchange rate regime transition dynamics in Southeast Asia. Journal of Developing Areas (1). pp 350 – 373 Read More