ACE 2017
INCOME GAP AND EXCHANGE RATE REGIME IN ASEAN Ngoc Hong Nguyen A.Prof. Charles Harvie Prof. Sandy Suardi
CONTENTS 1. KEY TERMS 2. MOTIVATION 3. AIMS AND SIGNIFICANCE OF THE STUDY 4. BACKGROUND 5. RESEARCH QUESTIONS 6. METHODOLOGY 7. EMPIRICAL RESULTS 1
1. KEY TERMS ASEAN (Association of Southeast Asian Nations): Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam. Income gap: is the difference in income per capita between countries Exchange rate is the price of one currency in terms of another currency. Exchange rate regime (ERR): is the way that a country manage the exchange rate. Government s intervention Foreign exchange market Fixed ERR Intermediate ERR Floating ERR Flexible ERR 2
1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 USD 2. MOTIVATION The ASEAN economic community (AEC): established in 2015 with aims: - to get closer regional economic integration - to protect region from future economic shocks - to support economic growth, macroeconomic stability 90,000.00 80,000.00 70,000.00 60,000.00 50,000.00 40,000.00 30,000.00 20,000.00 10,000.00 - to reduce income gap between ASEAN countries. 0.00 Graph 1: GDP/CAPITAL, PPP OF ASEAN COUNTRIES (1995-2013) Source: World Bank, quandl.com Vietnam Laos Cambodia Myanmar Thailand Singapore Brunei Philippines Malaysia Indonesia 3
Economic integration: ASEAN is more vulnerable to unexpected external shocks. - a negative factor on economic growth & macroeconomic stability (Raddatz 2007) - the greater income gap for ASEAN countries, (Masron & Yusop 2008). External shocks may affect the success of AEC Exchange rate regime: an instrument to deal with external shock 6
3. AIMS AND SIGNIFICANCE OF STUDY 3.1. Aims: - This study will investigate the optimal exchange rate regime for ASEAN countries to minimise the negative effects of external shocks. Foreign demand shock a common shock for all countries (Dollar & Kraay 2004) Under fixed ERR Under flexible ERR Real GDP, CPI, Real exchange rate, Income gap 4
3.2. Significance of study - The first time the effect and contributions of foreign demand on macroeconomic variables under different ERRs are investigated. - Enriching the empirical evidences for the choice of ERR by sample of ASEAN countries. - Extending the existing literature on the choice of ERR by adding income gap into a theoretical and empirical model. - The first time de facto exchange rate regime classification of IMF is applied. 5
4. BACKGROUND AIM - to investigate which is the optimal exchange rate regime. Factors Fixed ERR Flexible ERR SHOCKS Foreign/domestic nominal shocks, foreign/domestic real shocks Shocks Domestic nominal shock Foreign nominal/ real shocks, domestic real shock MACROECONOMIC VARIABLES Real GDP, CPI, real exchange rate, trade balance. Size of economies Small Large METHODOLOGY Panel VAR, panel VAR with exogenous, panel structural VAR Openness Open Closed Capital mobility Low High 6
5. RESEARCH QUESTIONS 1. What are the differences in the effects and contribution of foreign demand shocks on macroeconomic variables between fixed and flexible ERRs? 2. What is the exchange rate policy for ASEAN countries? 7
6. METHODOLOGY Structural Vector Autoregressive model: AY it = c it + A L Y it + E(L)X it + d + u it Y it : endogenous variables: foreign demand, real GDP, real exchange rate, CPI and income gap. account. X it : control variables: trade openness, government spending, financial development, current To distinguish the responses of variables between fixed & flexible ERRs, Y it and X it will be interacted with dummy variables for ERR (D fixed =0 if fixed and D flex =1 if flexible ERR). 8
7. EMPIRICAL RESULTS Figure 1: Impulse response to a negative foreign demand shock Fig. 1.1a: Real GDP under fixed regime Accumulated Response of D(LREALGDP_NATIONAL_CPI)*(ERR2=0) to Shock1.04 Fig. 1.1.b: Real GDP under flexible regime Accumulated Response of D(LREALGDP_NATIONAL_CPI)*(ERR2=1) to Shock1.04.02.02.00.00 -.02 -.02 -.04 -.04 -.06 Fig. 1.2a: Real exchange rate under fixed regime -.06 Fig. 1.2b: Real exchange rate under flexible regime Accumulated Response of DLREALER*(ERR2=1) to Shock1 Accumulated Response of DLREALER*(ERR2=0) to Shock1.2.2.1.1.0.0 -.1 -.1 -.2 -.2 -.3 -.3 9
Fig. 1.3a: CPI under fixed regime Fig. 1.3b: CPI under flexible regime Accumulated Response of DLCPI*(ERR2=0) to Shock1 Accumulated Response of DLCPI*(ERR2=1) to Shock1.04.02.04.02.00.00 -.02 -.02 -.04 -.04 -.06 -.06 -.08 -.08 -.10 -.10 Fig. 1.4a: Income gap under fixed regime Fig. 1.4b: Income gap under flexible regime Accumulated Response of D(IGPPP)*(ERR2=1) to Shock1 Accumulated Response of D(IGPPP)*(ERR2=0) to Shock1.02.02.00.00 -.02 -.02 -.04 -.04 -.06 -.06 -.08 -.08 10
Figure 2: Percent variance of variables due to a negative demand shock Fig. 2.1a: Real GDP under fixed regime Fig. 2.1b: Real GDP under flexible regime Percent D(LREALGDP_NATIONAL_CPI)*(ERR2=0) variance due to Shock1 80 70 60 50 40 30 20 Percent D(LREALGDP_NATIONAL_CPI)*(ERR2=1) variance due to Shock1 100 80 60 40 20 10 0 0 Fig. 2.2a: Real exchange rate under fixed regime Fig. 2.2b: Real exchange rate under flexible regime Percent DLREALER*(ERR2=0) variance due to Shock1 Percent DLREALER*(ERR2=1) variance due to Shock1 50 100 40 80 30 60 20 40 10 20 0 0 11
Figure 2: Percent variance of variables due to the foreign demand shocks Fig. 2.3a: CPI under fixed regime Percent DLCPI*(ERR2=0) variance due to Shock1 Fig. 2.3b: CPI under flexible regime Percent DLCPI*(ERR2=1) variance due to Shock1 100 80 70 80 60 60 40 50 40 30 20 20 10 0 Fig. 2.4a: Income gap under fixed regime 0 Fig. 2.4b: Income gap under flexible regime 60 Percent D(IGPPP)*(ERR2=0) variance due to Shock1 60 Percent D(IGPPP)*(ERR2=1) variance due to Shock1 50 50 40 40 30 30 20 20 10 10 0 0 12
POLICY IMPLICATIONS Criteria Real output, real exchange rate Inflation Income gap Optimal ERR Fixed exchange rate regime Flexible exchange rate regime Flexible exchange rate regime Fixed ERR Flexible ERR Consider the unanticipated foreign demand shocks Foreign demand shocks are not important. 13