The Return to Soft Dollar Pegging in East Asia: Mitigating Conflicted Virtue


Ronald McKinnon
Department of Economics
Landau Economics Building
Stanford University
Stanford, CA 94305-6072
Gunther Schnabl
University of Tübingen
Department of Economics
Nauklerstr. 47
72074 Tübingen


Before the 1997–98 crisis, the East Asian economies – except for Japan – informally pegged their currencies to the dollar. These soft pegs made them vulnerable to a depreciating yen, thereby aggravating the crisis. To limit future misalignments, the IMF wants East Asian currencies to float freely. Alternatively, authors have proposed increasing the weight of the yen in East Asian currency baskets. However, dollar pegs are entirely rational from the perspective of each Asian country – both to facilitate hedging by merchants and banks against exchange risk, and to help central banks anchor their domestic price levels. Post-crisis, as the East Asian economies transform themselves from being dollar debtors into dollar creditors, they face ‘conflicted virtue’: pressure to appreciate their currencies that could lead to a deflationary spiral. Rather than undervaluing their currencies to promote exports as is commonly alleged, East Asian governments are trapped into returning to – and then maintaining – soft dollar pegs.