External shocks and the exchange rate regime: The case of ASEAN countries

ASEAN is a good representative example of regional economic cooperation and integration as well as among developing countries in general. ASEAN was established in 1967 and originally consisted of five members. However, this organization has subsequently achieved deeper and wider political and economic cooperation and expansion to 10 member countries. Due to changes in the world economy, international economic interdependence and crises, ASEAN members initiated the ASEAN Economic Community (AEC) from December 2015, due to be completed by 2020, with the aim of transforming ASEAN into “a stable, prosperous, and highly competitive region with equitable economic development, and reduced poverty and socio-economic disparities” (ASEAN 2008). The attainment of the AEC in 2020 will represent a major landmark in terms of regional economic integration of ASEAN countries and for East Asia as a whole. The AEC has four objectives; achieving a single market and production base; becoming a highly competitive economic region; attaining equitable economic development; and becoming fully integrated into the world economy. Achieving high trade openness and more integration to the global economy, however, makes ASEAN economies more vulnerable to external shocks. This may have negative impacts on economic stability and growth which then affect the income gap between and within ASEAN countries. This is because ASEAN member countries may respond differently to common external shocks. As a result, ASEAN may fail to achieve one of its stated pillars for success - equitable economic development in which not only the within-country but also between-countries income gap is narrowed. In the literature the exchange rate regime is seen as an instrument that can minimise the negative effects of shocks on the stability of macroeconomic variables such as real output, the price level and the real exchange rate. Due to the impacts that these variables have on within-country and between-countries income gaps, the exchange rate regime may also play an important role in limiting the effects of these shocks on these income gaps. Yet this is a relationship that has not been investigated in the literature.