Moving Towards Monetary Integration in East Asia: Achieving Economic Convergence in a Game-Theory Framework

Abstract

This paper considers the current perspective of coordinating efforts to stabilize exchange rates in East Asia, viewed as the first and essential stage of monetary integration process. In this context, the effects of asymmetric demand and supply shocks affecting the two countries are considered, with the help of a game-theory model, and the outcomes from cooperative and non-cooperative fiscal policy responses are analyzed. The properties of fixed-exchange rate arrangements are analytically treated and numerically simulated in a situation where fiscal policies are left as the only device to deal with asymmetric shocks, both on the demand side and the supply side. The model prediction is that both asymmetric demand and supply shocks may be contrasted with the help of fiscal policies, without damaging consequences for the fixed-exchange rate arrangement. The model also suggests that the results will prove better when the fiscal response to the asymmetric shocks is coordinated. Not differently than what happened in Europe following the implementation of end stages of monetary integration, asymmetric fiscal policy response to asymmetric supply shocks may bring about the piling up of huge public debt, and pave the way to sovereign debt crises. Arguably, in such a situation joint fiscal responsibility may help reinforcing the process of integration and convergence.