A Monetary Union in East Asia: Common Cycles Approach

Abstract

It has been a hot debit whether a monetary union is feasible in the East Asian region. Most of the existing studies focus on the symmetric issue of the fundamental shocks and the extent of correlation by applying the Blanchard and Quah (1989) structural vector autoregression (VAR) technique, which includes the first-differenced variables in the model and examines only the bilateral relationship. However, the shock symmetry does not necessarily mean the co-movements of the real output variables (common business cycles) between the countries concerned. The present paper employs the Johansen (1988) cointegration test to check the long-run co-movements 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 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 long-run and the short-run dynamics of the real variables to determine the suitability and costs of forming a monetary union in the region.