Econometric Analysis of the Exchange Rate Regimes for Asia-5 Countries during
Pre and Post-Asian Economic Crisis in 1997
Amirullah Setya Hardi (201255003)
Abstract

In the "impossible trinity", the exchange rate policy implies the choice of exchange rate regime inwhich a country determines their exchange rate regime either following the free exchange rate
regime or fixed regime. In fact, during the twentieth century the possible choice of exchange rate
regime was not only either fix or free-floating but also something in between, e.g. adjustable rates,
crawling peg, etc. The exchange rate regime other than fix and free-floating regimes have also
been widely implemented by many countries especially emerging market. We review studies ontaxonomy of the exchange rate regime as well as the description of the types of exchange rate
regime which is usually adopted in many countries.

International Monetary Funds (IMF) has considerable influence in the development of theexchange rate regime, besides IMF play important role as the world's financial institutions thatprovide financial support for its member countries. Related to the exchange rate regime, since1970’s the IMF recorded the official announcement (or usually known as “de jure”) exchange rate
regime in member countries. However, in the late 1990s the IMF changed the classification methodof the exchange rate regime in member country and put more emphasis to observe on what member
country actually conducted to their exchange rate regime (or known as “de facto”).
Since 1970’s, the official announcement regarding the exchange rate regimes in Indonesia has
been conducted 3 times. Therefore, until recently the de jure exchange rate regime in Indonesia
can be divided into 3 periods as follows: (1) 1966 – October 1978: rupiah was under fixed regime(fixed to the US dollar); (2) November 1978 – July 1997: rupiah was under managed-floating withbasket currencies under several adjustment including widening band intervention during 1992 –July 1997; (3) August 1997 - present: regime changed to free-floating (rupiah was highly volatile
against the US dollar during the Asian Crisis).

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It is obvious that by observing the rupiah movement during period (1), the evidence shows thatrupiah was really fixed to the US dollar. The same thing also happened during the period (2), wherethe movement of rupiah was no longer fixed as in previous period. However, some evidences areneeded to exactly understand about what is really happening with Indonesian currency movement
during period (3). Since the exchange rate regime was officially announced as free-floating but therupiah movement in reality does not really reflect high volatile movement, since the rupiahmovement, theoretically, should be determined mainly by market mechanism. The purpose of thischapter is to obtain statistical evidence related to the de facto exchange rate regime, particularly
during the post-Asian crisis 1997.

We examine de facto regime which is conducted by Bank Indonesia. By examining de facto regime
we will obtain statistical evidence that explains the exchange rate management conducted by Bank
Indonesia during pre-Asian crisis. The estimation result shows that there was no deviation between
de jure and de facto in period (1). Although the estimation results show that during period (2)rupiah was under managed-floating but the US dollar still became main reference to the Indonesianrupiah. The actual movement of rupiah in the period (3) was still tightly pegged mainly to the US
dollar except in several periods with different degree of pegging depend on the market pressures.

We modified and applied Frankel-Wei (2008) model to infer the de facto exchange rate regime inIndonesia. This model is regression equation and used as a technique for inferring implicit basket
weight and exchange rate flexibility (or inflexibility) in several countries under the assumptionthat the home currency is determined by a basket of currency. By applying these methods, wefound that during the fixed regime, the exchange rate was consistently followed fixed exchange
rates, in other words de jure equal to the de facto regime. During the de jure managed-floating
regime, our finding shows that rupiah was still heavily managed and tightly pegged to the USD(although the official statement of the regime was the rupiah will be pegged on a basket currencies).
Therefore, we classify the de facto regime as adjustable peg or crawling peg. We conclude that
under de jure managed-floating, the actual rupiah movement was more volatile but still heavily
pegged to single hard currency rather than to basket of currencies. Our estimation results show thatduring the post-Asian crisis period, the exchange rate regime can be classified as managed-floating
rather than free-floating. In addition, the regression results clearly reveal a situation where2intervention might be taken to maintain the rupiah movement. During the “tranquil” period, anintervention was taken by accumulating foreign reserve to avoid appreciation of the rupiah, whileduring the “turbulent” period the intervention was taken by dis-accumulating foreign reserve toavoid further depreciation.

During the onset of Asian crisis 1997, five Asian countries i.e. Indonesia, Malaysia, Philippines,Thailand and South Korea (later, it is called as Asia-5) officially announced to switch theirexchange rate regimes. Malaysia decided to change their regime to fixed regime (Malaysia ringgit
was perfectly pegged to the US dollar), while other four Asia-5 countries decided to adopt freefloating regimes. However, in July 2005 Malaysia announced that Malaysia ringgit was no longer
perfectly pegged to the US dollar. Although the official exchange rate regimes announced to follow
free-floating regime but realization of the nominal exchange rate of the Asia-5 currencies during
2000-2013 did not fully reflect this condition. It seems that these Asia-5 currencies were not only
determined by market mechanism there were strong intentions to bring the exchange rate of theircurrencies in a particular direction or particular level.

There are several statistical tests conducted in this chapter, including regression model developed
by Frankel-Wei (2008), index of flexibility as in Baig (2001), recursive regression analysis,
asymmetric response model, scatterplot analysis, and Wald test. The estimation using of mentioned
statistical tests as well as the comparison analysis among the surveyed countries verifies whether
the exchange rate arrangements revert to the regime as before the 1997 crisis. Based on thestatistical evidences, it can be concluded that the Asia-5 exchange rate arrangement during thepost-Asian crisis 1997 did not fully follow the floating regime, rather it more likely to be managed
float with the US dollar as the main reference. In addition, the Asia-5 countries allow theircurrencies to move more flexibly as indicated by the index of flexibility. These findings suggestthat returning to the US dollar pegged is inevitable but in slightly lower degree of pegging.

A structural change usually appears in time series data due to external or internal shocks (i.e. policychange, natural disaster, etc). Therefore, we consider structural change in a linear time-series
regression model with GARCH errors where a structural change implies the change in theregression coefficients at time m. Then we detect the time of the structural change by testing the3null of 𝐻0 : no structural change at time m against the alternative 𝐻1 : there is structural change attime m. The most common test for this is the Chow test based on the F-statistic. It is generally
difficult to obtain a theoretical distribution of the estimated change point regardless the statistical
test we used. To overcome this difficulty, we consider the use of a circular block bootstrap (CBB)
method to obtain the sampling distribution of 𝑚̂ and use this to construct confidence intervals.

We evaluate the performance of the sum of squares of residual and circular block bootstrap(SSR/CBB) as well as log-likelihood ratio and circular block bootstrap (LR/CBB) methods using
Monte Carlo experiments. The LR/CB is generally better than the SSR/CBB in many respects, theperformance of the LR/CBB is more sensitive than the SSR/CBB to the location of the true change
point, the block length specified in the CBB, and the number of parameters to be estimated. Our
empirical study, the SSR/CBB detect a change point and drew a reasonable economic
interpretation that even though the Indonesian government had officially announced a floatingexchange rate regime, the IDR was not floating throughout the whole sample period but has moved
with the USD since March 2002 and has also become less volatile.

The economic phenomena can be described by explaining a relationship of several variables thatshows cause and effect among the variables. To scrutiny the relationship among these variables,
economics theories are needed as a basis to describe the relationship among observable variables
as required in the theory. Unfortunately, not all economic variables are observable but some ofthem are unobservable, and consequently the data of the unobservable variables cannot beprovided. To overcome this problem, a measurement of relationship among the variables is needed.
There are two important issues arise here, i.e. theory and measurement.

The causal order of hard and soft currencies will be presented as an example of the application of
Independent Component Analysis (ICA) with real data analysis. Several hard currencies such as
US dollar, Japanese yen, Germany mark as well as soft currencies such as Singapore dollar andIndonesian rupiah is selected to be analyzed in term of its causal order. Our conjecture is that thesoft currencies will be highly affected by fluctuation of the hard currencies value.

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Our empirical study in this chapter estimates the causal order based on four nominal exchange
rates of the US dollar against Special Drawing Right (USD/SDR), Euro against Special Drawing
Right (EUR/SDR), Japanese yen against Special Drawing Right (JPY/SDR), and Indonesianrupiah against Special Drawing Right (IDR/SDR). We collect monthly data from January 2000 toDecember 2014 and divided into 2 periods, i.e. pre-Lehman shock (January 2000 – August 2008)
and post-Lehman shock (September 2008 – December 2014). The estimation result (see Table 5.4)
show that the causal order before Lehman shock is

𝑈𝑆𝐷𝑆𝐷𝑅 → 𝐸𝑈𝑅𝑆𝐷𝑅 → 𝐽𝑃𝑌𝑆𝐷𝑅 →𝐼𝐷𝑅𝑆𝐷𝑅 and the causal order after Lehman shock is 𝐸𝑈𝑅𝑆𝐷𝑅 → 𝑈𝑆𝐴𝑆𝐷𝑅 → 𝐽𝑃𝑌𝑆𝐷𝑅 →𝐼𝐷𝑅𝑆𝐷𝑅.

The circular block bootstrap (CBB) method has been applied to construct a confidence interval forthe estimated single change point. To apply the CBB, it requires user to specify the length of blocklength. Our simulation results have shown that under the same scenario, the use of different block
length lead to construct different confidence interval. In some cases, using short block length
obtained better results, and in other cases longer block length also produced better result inconstructing the confidence interval.

Our simulation result suggests that the block length is very sensitive in constructing confidence
interval, especially when CBB method is applied. In addition, time dependent in the error term
must be considered when choosing the block length. In this simulation study, we obtain someevidences that the short block length should be chosen when the series is less time dependent aswell as for strong time dependency data.

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