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August 2002
Since the early 1980s, the smaller East Asian economies have experienced a synchronized business cycle. Before the Asian crisis of 1997-98, they pegged their exchange rates to the US dollar. Post crisis, we show that they have resumed dollar pegging on a high frequency, i.e., day-to-day, basis, with indications of a possible return to pegging at lower frequencies as well. The joint exchange rate stabilization of their currencies against the dollar reduces payments risk and strengthens trade linkages in the region. However, it has also made East Asian economies more sensitive to fluctuations in the yen/dollar exchange rate. Sudden yen depreciation slows regional economic growth, and yen appreciation accelerates it. Against this, China�s macroeconomic and exchange rate policies have been a critically important stabilizing influence. Because Japan�s own economic slump can also be linked to the fluctuating yen/dollar exchange rate, and any deep depreciation of the yen would be economically disastrous for the whole East Asian region, we conclude that East Asia is a natural dollar zone that Japan should consider joining.