Modelling and Simulation Society of Australia and New Zealand
Faculty of Business and Law
School of Accounting, Finance and Economics
There is controversy about whether a monetary union is feasible in the East Asian region. Amongst the criteria for establishing a monetary union, most of the existing studies focus on the symmetric issue of fundamental shocks and the extent of correlations by applying the Blanchard and Quah (1989) structural vector autoregression (VAR) technique, which includes the firstdifferenced variables in the model and examines only bilateral relationships. When forming a monetary union, the member countries need to renounce their monetary policy autonomy. If shocks to respective economies are symmetric, the cost of relinquishing the discretionary monetary policy is likely to be outweighed by the benefits of establishing a common currency. In contrast, if shocks are asymmetric, it will be more costly to give up the autonomous monetary policy and, hence, to establish a monetary union. However, the shock symmetry does not necessarily mean the comovements of the real output variables (common business cycles) between the countries concerned are present. The present paper employs the Johansen (1988) cointegration test to check the long-run comovements of real outputs and also conducts the Vahid and Engle (1993) common feature test to detect the short-term common business cycles. The novelty of this paper is twofold. First, whereas the structural VAR approach considers shocks to correlation bilaterally, we use a multivariate VAR framework to allow for the relationships within a specific group of countries. Second, we employ the cointegration technique to examine both the longrun and the short-run dynamics of linkage of the real variables to determine the suitability and costs of forming a monetary union in the region. We include in this study Japan and the United States in addition to the nine East Asian economies including three Asian NIEs (Korea, Taiwan and Hong Kong), ASEAN5 (Singapore, Malaysia, Indonesia, Thailand and the Philippines), and Mainland China to investigate the co-movements of the real output variables spanning a period from 1978Q1 to 2006Q4. We first perform the Johansen (1988) cointegration test to check whether a group of countries concerned shares common stochastic trend(s), and then, conduct the Vahid and Engle (1993) common feature test to explore the existence of short-term common business cycles among the countries if the real output series are cointegrated. This will allow the assessment of how the output variables among these countries interact in both the short-term and long-term within a multivariate framework. The cointegration results and the common feature tests will ensure business cycle synchronization across the economies and determine the effectiveness of a common monetary policy to a union-wide shock. Based on a multivariate framework, this study will provide important implications for cost effectiveness in establishing a regional monetary union. The results of the Vahid and Engle (1993) common feature test indicate that there exists a linearly independent common feature vector, i.e., a linear independent combination of real output growth which has no correlation with the relevant past. This leads to the conclusion that besides the cointegrating relationship of real outputs, the concerned countries share common short-term business cycles. In particular, the results for the presence of one or two common feature vector(s) indicate the existence of synchronized common business cycles in two groups: the first one includes the Asian NIEs that consists of Korea, Hong Kong and Singapore, and the second one the ASEAN5 plus Japan. These economies would be the good candidates for a monetary union as they share both long-run output co-movements as well as synchronized common business cycles. However, the results show that the United States and China are not suitable for a membership of the grouped economies, as do the ASEAN5 and Japan.