Choice of Exchange Rate System and Macroeconomic Volatility of Three Emerging Asian Countries

This study highlights the importance of choice of exchange rate system to macroeconomic stability of small- open countries based on the outcomes of the recent exchange rate regime switches of three small Asian countries during the post Asian financial crisis period. The three selected countries are Indonesia, Malaysia and Thailand, which have high similarities in their economic structures, but have reacted very differently in mitigating the economic distortion of the 1997 financial crisis, in particular in the adoption of exchange rate system. By focusing on macroeconomic volatilities of these countries, our results show that the amplified volatilities due to the crisis were not stabilised by switching the system to a more flexible regime. For instance, Thailand and Indonesia had switched their system from a managed-float to an independent-float, and as a result, the volatilities were increased instead of reduced after the switch. The volatilities, however, were effectively stabilised after the countries made the second switch - from the independent-float back to the managed-float with pre-announcement. For Malaysia, a switch from the managed-float to the pegged system successfully reduced the volatilities. The exchange rate misalignments of the countries, except Indonesia, were also reduced when the countries switched from a flexible to a more fixed system. These empirical findings thus strongly support central banks of small-open economies to adopt a more fixed, such as the managed-float system, rather than a flexible, such as the independent-float. However, the managed-float system needs to couple with efficient management to ensure a smooth and stable regime