HOW DID THE MALAYSIAN REAL EXCHANGE RATE MISALIGN DURING THE 1997 ASIAN CRISIS?

Abstract

Currency  overvaluation seems tobe the prominentexplanation for the  1997–98 Asian financialcrisis. Although this is the case, the reinstatement to  managed float  exchange rate  regimeinmid-2005, as wellas the  instability of commodity prices and the recent 2008–2010 global economic  crisis, leads to the questionofhowfar the fluctuationinthe Malaysian ringgit isconsistentwiththe changes initseconomicfundamentals. Based  on the theory of real equilibriumexchangerate, this paper estimates the  NATREX approach tomodelingthe Malaysianequilibriumexchangerate  from 1991 to2009. The empiricalresultsshow thatthe ringgittook a U-turn  from  being  overvalued during the pre-crisis(1991–1997) tobeing  undervalued inthe post-crisis  (1997–2002) periods, before fluctuating  around its long-run equilibriumfor the rest of the period. This corroborated  the hypothesis that an overvaluation leads toa currencycrisis, which is followed bysubstantial currency devaluation.The misalignment rates then reduce andremainclose tothe equilibriumpath.  

JEL Classification:C32, F31, F41  

Keywords: Asiancrisis, Global financial crisis, Real  exchange  rate  misalignment, NATREX model, Malaysia