The suitability of a monetary union in East Asia: What does the cointegration approach tell?
Introduction
In recent years, the feasibility of forming a monetary union and establishing a regional (common) monetary unit in East Asia has been a subject of lively debate in industrial, governmental and academic arenas. The post-crisis experience has provoked calls among politicians for further monetary integration and alternative regional exchange rate arrangements in East Asia to enhance the stability and credibility of the exchange rate system. In 2000 ASEAN plus China, Japan and Korea (known as ASEAN + 3) agreed to establish a currency-swap network in order to help avert any future crisis,1 and again in 2003 decided to establish an ASEAN Economic Community (AEC) by 2020. At the ADB 39th annual meeting in 2006, ASEAN + 3 finance ministers agreed to take over the ADB's controversial plan to launch an Asian Currency Unit (ACU) with the hope of making it the region's legal currency in the future.
According to the seminal work of Mundell [19] and McKinnon [18], the incentive for two economies to peg their bilateral exchange rates rises with the bilateral intensity of trade, flexibility of factor markets, and symmetry of underlying shocks. By doing so, both will be able to forsake nominal exchange rate changes as an instrument of adjustment and to reap the reduction in transactions costs associated with a common currency. In general, the identified preconditions for forming a monetary union include: (i) the openness and degree of goods market integration; (ii) factor market integration; (iii) similarity in economic structure and symmetry in (real) shocks; (iv) financial market integration; and (v) policy coordination.2 Most of the existing studies focus on the symmetric nature of the fundamental shocks and use the Blanchard and Quah [5] structural vector autoregression (VAR) technique to identify the fundamental shocks. Specifically, the Blanchard–Quah approach typically imposes long-run restrictions so that only the supply (real) shock affects the real output growth in the long-run and both the supply and demand (nominal) shocks have a long-run influence on the domestic price inflation. Given that real output fluctuation is subject to supply shocks in the long-run, the symmetry in the supply shock is an important precondition for forming a monetary union. If the supply 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 the shocks are asymmetric, it will be more costly to give up the benefits of autonomous monetary policy and, hence, to establish a monetary union.
The shocks correlation approach3 has several weaknesses. First, a correlation analysis of shocks identified by the structural VAR is inherently a bivariate method, whereas it is obvious that an analysis of OCA must be based on a multi-country framework. More specifically, what a bivariate approach reveals is just the country-to-country correlations without taking into account the relationship with other possible partner countries. A multi-country approach will thus be more appropriate to examine the monetary arrangement within a particular group of countries.
Second, it is important to distinguish between the short- and the long-run dynamics in consideration of a monetary union.4 If real output variables are not cointegrated amongst the countries concerned, each output variable wonders randomly over time, which may lead to a different growth path for each country. Since the nominal exchange rate changes as well as other macroeconomic stabilization policies have only transitory effects on the economy, the long-run economic divergence among the economies can be an obstacle to forming a monetary union. The Blanchard–Quah approach generally employs a bivariate VAR model including first-differenced variables, which as a result will be likely to remove any information about the long-run equilibrium relationship.
In contrast to the previous studies, the novelties of this paper are twofold. First, we apply the multivariate cointegration technique to the issue of an East Asian monetary union. Recently Cheung and Yuen [6] and Sato and Zhang [22] employ the cointegration technique to assess the integration issue, but Cheung and Yuen [6] focus only on the three Greater China economies (the Mainland, Hong Kong and Taiwan). Even though Sato and Zhang [22] investigate the whole East Asian economies, they employ a bivariate VAR of real output series for possible pairs of countries within a two-country framework. In contrast, the present paper features an investigation of whether a group of East Asian countries share a common stochastic trend of real outputs by using a multivariate VAR framework.5 Second, we attempt to investigate 60 groups of countries to detect possible regional currency areas, which is far more comprehensive than the previous literature.6 We include in this study Japan and the United States in addition to 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. Based on a multivariate cointegration approach, this study will provide important implications for cost effectiveness in establishing a regional monetary union.
The rest of the paper is structured as follows. In Section 2 we discuss the analytical framework for this study. Section 3 describes the data and presents the results of the empirical examination. Finally, Section 4 concludes the paper.
Section snippets
Analytical framework
To investigate the existence of a stable linear steady-state relationship between the set of variables, we need to conduct both the unit root and cointegration tests to determine whether a time-series variable is stationary, and whether there is a long-run (cointegrating) relationship between the variables if all the variables are found to be non-stationary (i.e., have unit roots). If all variables studied are I(1) non-stationary, we proceed to the Johansen maximum likelihood (ML) method
Data
We use the quarterly series of real GDP for cointegration analysis of real outputs among the concerned economies. All data are expressed in natural logarithms and seasonally adjusted using the Census X-12 method. The 11 economies taken up in this paper include the three Asian NIEs (Korea, Taiwan and Hong Kong), ASEAN5 (Singapore, Malaysia, Indonesia, Thailand and the Philippines), China, Japan and the United States. The sample period covers 1978Q1 through 2006Q4 for all economies. The data on
Concluding remarks
This study adopts a multivariate cointegration approach to evaluate the feasibility of a monetary union in the East Asian region. The results suggest that some groups of Asian NIEs plus the United States and ASEAN5 plus Japan are potential candidates to form a monetary union as these grouped economies share long-run real output co-movements. Interestingly, mainland China is not suggested to be a potential member country of a monetary union with any of the grouped economies. Furthermore, the
Acknowledgements
The authors would like to thank Michael McAleer, Colin McKenzie, Kentaro Kawasaki, Mica Panić, Masanaga Kumakura, Tze Haw Chan and Craig Parsons for their insightful comments on the earlier version of the paper. The study is financially supported by Japan Society for the Promotion of Science through the Grant-in-Aid for Scientific Research (B), 116330059. The last two authors wish to acknowledge the financial support of a Strategic Research Grant at ECU.
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