Title

Towards an East Asian monetary union: An econometric analysis of shocks

Document Type

Conference Proceeding

Publisher

Modelling and Simulation Society of Australia and New Zealand

Faculty

Business and Law

School

Accounting, Finance and Economics

RAS ID

8154

Comments

Originally published as: Sato, K., Zhang, Z. Y., & McAleer, M. (2005). Towards an east asian monetary union: An econometric analysis of shocks. Paper presented at the MODSIM05 - International Congress on Modelling and Simulation: Advances and Applications for Management and Decision Making, Proceedings, 946-952. Original article available here

Abstract

A regional monetary arrangement is actually not something new to the East Asian economies. History of monetary co-operation in the region can be traced back to the establishment of an ASEAN Swap Arrangement among ASEAN member countries in 1977. With the recent outbreak of the Asian financial crisis and the introduction of the euro in Europe, renewed attention has been given to potential monetary integration in East Asia. There have been few studies regarding the viability of an optimum currency area (OCA) in East Asia. This paper reexamines the viability of regional monetary integration in East Asia by focusing on the symmetry of structural shocks as one of the preconditions for forming an OCA. In particular, we attempt to extend the conventional structural VAR approach by employing a 3-variable and a 5-variable VAR model to identify the corresponding supply, demand, and exchange rate shocks, as well as the foreign shocks and countryspecific shocks. Impulse response function analysis is applied to examining the size of these underlying shocks and the speed of adjustment to disturbances. For comparison purpose, we also conduct a similar study for the European countries. All data used in this study are quarterly, expressed in natural logarithms and seasonally adjusted, except for exchange rates. The sample period covers 1981Q1-1996Q4 for the East Asian economies and the USA, and 1980Q1-1997Q4 for the European countries. The results show that it is less suitable for the whole East Asian region to form an OCA than has been suggested in previous studies, as the identified underlying shocks (supply and demand shocks) are significantly correlated only among a few ASEAN economies and Asian NIEs. This conclusion is assured when we compare the correlation patterns of the underlying shocks with those of the European countries. The results also show that Japan has no significant correlations in supply, exchange rate and demand shocks with other East Asian economies, which is in contrast with the case of Germany in the European region. The impulse response function analysis concludes that, although the underlying structural shocks are less symmetric and the average size of the shocks is larger, the speed of adjustment to shocks in East Asia is much faster than in the EU region. On average, it takes less than one year to complete the adjustment to shocks. This is largely due to the fact that the labour market and wage rates in most East Asian economies are relatively more flexible, so that it is easier for the economies to make an internal adjustment in response to shocks. Although the results do not suggest an OCA in the entire East Asian region, they do imply that some sub-groups of the economies, such as some Asian NIEs and ASEAN economies, are more appropriate candidates as their underlying shocks are correlated and symmetric, and the speed of their adjustment to shocks is faster. Moreover, besides the symmetry of underlying shocks, theory also suggests the importance of other factors such as the intensity of intra-regional trade, flexibility of factor markets, and macroeconomic policy coordination, in determining the process of monetary integration. Further research on these issues will provide evidence regarding the viability of regional monetary integration in East Asia.

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