Exchange Rate Regimes, Capital Account Opening and Real Exchange Rates: Evidence from Thailand

This paper examines the roles of pegged exchange rate regime and capital
account opening inducing persistent RER appreciation in the lead-up to the 1997 currency crisis
in Thailand. The three-sector (primary, manufacturing, and nontradable) economy-wide model is
constructed and policy simulation experiments are undertaken. Key findings are imposing capital
control under a pegged exchange rate regime would have averted the persistent internal RER
appreciation and boom in nontradable sector. However, it would not have averted persistent
external RER appreciation. Exports and output would have eventually declined because of the
capital shortage. A freely floating regime only with a high developmental level of foreign
exchange and financial markets would have been able to avert both persistent internal and
external RERs appreciation. The export and output would have eventually increased. However,
this regime would have generated fluctuations in domestic prices and output. The managed
floating regime (combined with inflation targeting) would have helped reduce such adverse
effects while retaining the benefit from exchange rate flexibility. In a context where the foreign
exchange and financial markets are not well developed, capital control measures could be
beneficial to ensure smooth functioning of a managed floating regime.