Abstract
Debate continues over whether a monetary or currency union will be a viable alternative to the current exchange arrangements in East Asia. This paper adds to the literature by assessing the level of business cycle synchronization among 10 major East Asian economies which is considered a key precondition for a regional currency union. Unlike previous studies, this paper employs a factor-augmented vector autoregression model that characterizes a large set of 62 foreign and domestic variables simultaneously. Five common shocks are identified, and we examine how and to what extent these shocks affect each economy in the region. Empirical results indicate that the majority of East Asian economies exhibit similar responses to world and regional shocks. Of particular importance is the finding that individual gross domestic products (GDPs) are well synchronized in response to the two major determinants of world and regional GDP shocks. Overall, the evidence presents positively for consideration of a regional currency union in East Asia. Some suggestions are offered concerning steps to build a foundation towards the establishment of an East Asian currency union.
Highlights
East Asia has been among the fastest growing and most dynamic regions in the world for nearly the past half century
Variance decomposition analysis suggested that economy-specific idiosyncratic shocks have persistently significant effects on money growth in a number of economies. These results indicate that differences in the monetary policies of different economies may be the major source of cross-economy heterogeneity in the region
This paper empirically investigates the co-movements of key macroeconomic variables for 10 major East Asian economies (ASEAN5, Japan, the Republic of Korea, and the People’s Republic of China (PRC)) to shed light on the feasibility of a currency union in the region
Summary
East Asia has been among the fastest growing and most dynamic regions in the world for nearly the past half century. Freely floating exchange rates imply too much bilateral volatility in the region given the extent of its trade integration. This fact prompted a number of research and policy debates over alternative exchange rate arrangements to promote stability and credibility in exchange rates. The launch of the euro in 1999 simulated great interest in regional monetary integration or even a currency union for many economies, including those in East Asia. Along with these developments, East Asian economies stepped up efforts to enhance their financial stability through financial and monetary cooperation in the region. The theory of optimal currency area (OCA), introduced by Mundell
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