Optimum Currency Areas in East Asia: A Structural VAR Approach

Optimum Currency Area; Monetary Union; Vector autoregression; Exchange rate; East Asia Abstract: This paper assesses the empirical desirability of the East Asian economies to an alternative exchange rate arrangement (a monetary union) that can potentially enhance the exchange rate stability and credibility in the region. Specifically, the symmetry in macroeconomic disturbances of the East Asian economies is examined as satisfying one of the preconditions for forming an Optimum Currency Area (OCA). The Structural Vector Autoregression (VAR) method is employed to assess the nature of macroeconomic disturbances among the East Asian countries, as a preliminary guide in identifying potential candidates for forming an OCA. The preliminary findings of this study suggest that there exists scope among some small sub-regions for potential monetary integration.

A Bayesian Approach to Optimum Currency Areas in East Asia

This paper assesses the empirical desirability of the East Asian economies to an alternative exchange rate arrangement (a monetary union) that can potentially enhance the exchange rate stability and credibility in the region. Specifically, the symmetry in macroeconomic disturbances of the East Asian economies is examined as satisfying one of the preconditions for forming an Optimum Currency Area (OCA). We extend the existing literature by improving the methodology of assessing the symmetry shocks in evaluating the suitability of a common currency area in the East Asian economies employing the Bayesian State-Space Based approach. We consider a model of an economy in which the output is influenced by global, regional and country-specific shocks. The importance of a common regional shock would provide a case for a regional common currency. This model allows us to examine regional and country-specific cycles simultaneously with the world business cycle. The importance of the shocks decomposition is that studying a subset of countries can lead one to believe that observed co-movement is particular to that subset of countries when it in fact is common to a much larger group of countries. In addition, the understanding of the sources of international economic fluctuations is important for making policy decisions. Our findings also indicate that regional factors play a minor role in explaining output variation in both East Asian and the European economies. This implies that while East Asia does not satisfy the OCA criteria (based on the insignificant share of regional common factor), neither does Europe.Optimum Currency Area; Business Cycle Synchronisation, Monetary Integration; East Asia

THE ENDOGENEITY OF THE OPTIMUM CURRENCY AREA CRITERIA IN EAST ASIa

The Asian financial crisis in mid-1997 has increased interest in policies to achieve greater regional exchange rate stability in East Asia. It has renewed calls for greater monetary and exchange rate cooperation. A country’s suitability to join a monetary union depends, inter alia, on the trade intensity and the business cycle synchronization with other potential members of the monetary union. However, these two Optimum Currency Area criteria are endogenous. Theoretically, the effect of increased trade integration (after the elimination of exchange fluctuations among the countries in the region) on the business cycle synchronization is ambiguous. Reduction in trade barriers can potentially increase industrial specialization by country and therefore resulting in more asymmetry business cycles from industry-specific shocks. On the other hand, increased trade integration may result in more highly correlated business cycles due to common demand shocks or intra-industry trade. If the second hypothesis is empirically verified, policy makers have little to worry about the region being unsynchronized in their business cycles as the business cycles will become more synchronized after the monetary union is formed. This paper assesses the dynamic relationships between trade, finance, specialization and business cycle synchronization for East Asian economies using a Generalized Method of Moments (GMM) approach. The dynamic panel approach improves on previous efforts to examine the business cycle correlation –trade link using panel procedures, which control for the potential endogeneity of all explanatory variables. Based on the findings on how trade, finance and sectoral specialization have effects on the size of common shocks among countries, potential policies that can help East Asian countries move close toward a regional currency arrangement can be suggested. The empirical results of this study suggest that there exists scope for East Asia to form a monetary union.Optimum Currency Area; Monetary Union; Trade Integration; Business Cycle Synchronisation

The effect of cost of credit on money demand: empirical evidence from Malaysia

This paper investigates the dynamic of long-run relationship between cost of credit and real money balances in Malaysia. The Johansen-Juselius (1990) likelihood ratio tests support the importance of the cost of credit in the real broad money demand function. The sample period spans from 1978:q1 through 1997:q4. The results provide empirical evidence for the long-run relationship between cost of credit and broad money balances in Malaysia

Money, income and the Lucas critique: the case for Malaysia

The objective of this study is to determine the usefulness of the monetary aggregates in Malaysia for policy action purposes. Money MI and M2 were tested for weak exogeneity, strong erogeneity and superexogeneity (which implies Lucas critique) within a seasonal error-correction model framework. Our weak exogeneity and superexogeneity tests suggest that money MI and M2 are not subject to the Lucas critique and thus imply that both monetary awegates are useful intermediate targets for monetary policy purposes. The importance of money as intermediate targets is further strengthened as our seasonal error-correction model indicates that money (MI and M2) and income exhibit stable long-run relationships

Financial social accounting matrix: concepts, constructions and theoretical framework

A Social Accounting Matrix (hereafter, SAM) is a particular tool to represent that whole economic activities incomes and expenditures flows accounts through a socio-economic system, which captures the transactions and transfers between all economic agents and institutions in the system. During the last two decades, the financial market are well developed and significantly impacts the economic growth, it will be more worthy to move from a real SAM to a Financial SAM, containing the details of the financial institutions and transaction of agents’ assets and liabilities. Therefore, this paper will discuss the outlines and constructions framework for the aggregate Financial SAM. The understanding of the structure of Financial SAM can be a database for a financial Computed General Equilibrium (CGE) model and can be used to analyze the behavior of national’s public debt.SOCIAL ACCOUNTING MATRIX (SAM), FINANCIAL, FLOW-OF-FUNDS

Income Disparity between Japan and ASEAN-5 Economies: Converge, Catching Up or Diverge?

The objective of this study is to empirically examine the income disparity between Japan and each of the five major economies of South East Asia (ASEAN-5) during the period of 1960 to 1997, utilizing the popular augmented Dickey-Fuller (ADF) unit root test. The results provide evidence of income divergence between Japan and each of the ASEAN-5 economies. To avoid the problem associated with structural break, this study proceeds with the jointly crash and changes in trend model proposed by Zivot and Andrews (1992), and is able to obtain evidence of long run income convergence between the Japanese and Singaporean economies. As for the rest of the four ASEAN countries- Indonesia, Malaysia, the Philippines and Thailand, the earlier results of income divergence remain valid and hence suggest that it would be a more realistic and urgent goal to narrow the income gap among these five core economies of ASEAN.

Demand For International Reserves in ASEAN-5 Economies

The ASEAN-5 economies were observed to increase their demand for international reserves after the 1997 Asian financial crisis. This was coincided with their consistent current account surplus during the same period. Thus, this study attempts to investigate the existence of long-run relationship between reserve demand and current account for the period of 1997-2005. The Autoregressive Distributed Lag (ARDL) bounds test approach as proposed by Pesaran, Shin, and Smith (2001) was employed, and the empirical results revealed that current account surplus leads to the rise in the demand for international reserves in Indonesia, Malaysia, and Singapore.Bound Test, ARDL Approach, International Reserves, ASEAN-5

THE ASEAN-5 FUTURE CURRENCY: MAASTRICHT CRITERIA

In this recent decade, many of the economists and policymakers attempted to investigate the suitability of the East Asian region to form a currency union and based on the European countries experience as a benchmark. This study aims to investigate the long-run real convergence in GDP per capita growth among Malaysia, Thailand, Singapore, Indonesia, and the Philippines, over 1978 to 2004. The Dickey-Fuller (DF) and Augmented Dickey-Fuller (ADF) unit root tests were conducted at first difference of GDP per capita for each country; the results demonstrated that all countries GDP per capita are stationary at first difference. The results of the Bound Testing Approach (Auto-Regression Distributed Lag (ARDL)) indicated that there is a long run relationship between variables in the Maastricht Criteria. The results showed that interest rate, inflation rate and the debt ratio experience that negative relationship to the GDP per capita. However, the exchange rate and surplus (or deficit) ratio shown the positive related to the GDP per capita. Therefore, the findings showed the ASEAN 5 countries have fulfilled the Maastricht Criteria with consistent to expected sign(s) except for Singapore’ exchange rate and Indonesia’s debt ratio. Hence, those ASEAN 5 countries in this study have potential to form a single currency.Monetary Union (MU), Bound Test (ARDL), Maastricht Criteria, Single Currency