Establishing an Exchange Rate Mechanism (Erm) with Chinese Characteristics : An Option for Taiwan, China and Hong Kong to Prevent the Next Currency Crisis?

History shows that governments usually rethink their views on international macroeconomic cooperation after the emergence of a crisis. The response of the Asian countries after the speculative attacks occurred in 1997 may be considered as another example after the European ERM crisis in 1992-93. Nevertheless, some new ideas such as the creation of an 'Asian Monetary Fund' or an 'Asian single currency' may still stay at the stage of political slogans without a realistic executive plan until the next currency crisis occurs. Furthermore, even if a regional exchange rate and monetary cooperative mechanism would be implemented, it is still doubtful whether this would be enough to prevent the occurrence of another currency crisis in Asia or its sub-regional economies. The purpose of this paper is to provide an initial assessment whether an exchange rate mechanism with regional characteristics would be helpful to defend against possible future speculative attacks. We concentrate on the so-called "Chinese Economic Area (CEA)", a good experimental ground due to the cultural similarities and the close but indirect economic ties among the economies in the area. We consider the establishment of a Chinese Exchange Rate Mechanism (CERM) following Robert Mundell's multiple-currency union (2000a, b), in which all CEA members peg their currencies to an international currency in order to achieve the economic convergence and the stability of exchange rates. We apply a dynamic game approach to cooperative and non-cooperative scenarios and simulate the different sources of shocks according to the past experience of currency crises. Under the assumed CERM to induce the conflicts between internal and external economic situations, the values of the loss functions and the crisis indices indicate changes in welfare and the possibility of occurrence of a currency crisis in any of the economies belonging to the CEA. The parameters in the simulation are mainly based on calibration of econometric estimation for the CEA, but some reasonable adjustments are necessary. The simulation results for the CERM are only indicative but are a valuable reference to analyze the value of the regional exchange rates and the monetary cooperation in the policy choice