Prospects for enhanced exchange rate cooperation in East Asia: some preliminary findings from generalized PPP theory1

Abstract

The Asian financial crisis increased economic disparities in the East Asian (EA) region, thus making monetary integration more difficult, but rekindled political interest in Asian monetary and exchange rate cooperation. This article applies the theory of Generalized Purchasing Power Parity (G-PPP), which looks at the behaviour of long-run real exchange rates, to assess the potential for an optimum currency area (OCA) among a subset of EA countries based on five of the more advanced members of the Association of Southeast Asian Nations (ASEAN5). Our findings suggest little support for an OCA for ASEAN5 as a bloc prior to the Asian financial crisis and mixed results in the post-crisis period. In particular, asymmetries in the way countries adjust to shocks and low or insignificant speeds of adjustment were found. Thus, although the application of single OCA criteria is notoriously demanding and our tests apply to only one of the many criteria for the successful formation of an OCA, we cannot find persuasive evidence that ASEAN5 as a group constitute a potential currency area with either the USA or Japan, even when the ‘noisy’ period of the Asian financial crisis is omitted. 1 A first draft of this article was presented at the Western Economic Association International Pacific Rim Conference, Taipei in January 2003. We would also like to thank the Staff of the Regional Economic Monitoring Unit (REMU) at the Asian Development Bank (ADB) in Manila for their helpful comments on an earlier draft.