Should Asia Adopt a Currency Area

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Should Asia Adopt a Currency Area?

• Kate M. Li

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Motivation

• Interest in the Asian region
• Financial Crisis 1997

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Benefits from a Currency Area in Asia

• Increase in Trade
• Reduction in Exchange Rate Uncertainty
• Greater Market Transparency
• Spur New Growth

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Support

• Frankel and Rose (2001)
• Data set of economic and geographic variables for
  over 200 countries
• Results
• Common currencies promote bilateral trade
• By raising overall trade, Currency Union also
  raises income

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Support

• Ricardo Hausmann has stressed that currency union
  would help developing countries by increasing
  access to attractive forms of long term financing
• Barro (2001) argues that for most countries a
  C.A. provides a much better commitment device
  than alternative forms of fixed exchange rate

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OCA criteria

• Similarity in structure and shocks
• Openness of economies
• International factor mobility (Mundell 1961-labor
  mobility)
• Product Diversification (Kennen 1969)
• Fiscal Transfers (Kenen 1969)
• Degree of policy integration and similarity
  between rates of inflation (Dixit 2000)

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Methodology

• Qualitative approach
• OCA Index from Eichengreen and Bayoumi (1996)Is
  Asia an Optimum Currency Area? Can it become
  one? Regional, Global and Historical
  Perspectives on Asian Monetary Relations
• VAR from Eichengreen and Bayoumi (1994)

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Exchange Rate Variability
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OCA Index

• OCA Index is the predicted level of exchange rate
  variability
• Sample Japan and its 19 leading trading partners
  over the period 1976-1995
• Equation
• SD (eij ) a ß1 SD (?yi- yj ) ß2 DISSIM ij
  ß3 TRADEij ß4 SIZEij

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Results
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Symmetry of Shocks
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VAR

• Use the structural VAR methodology of Blanchard
  and Quah (1989) to provide a detailed analysis of
  asymmetric disturbances
• Sample 1972-1989

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Results

• The demand shocks of Hong Kong, Indonesia,
  Malaysia, Singapore, and Thailand are relatively
  highly correlated with one another
• The supply shocks side, 2 groups of Asian
  countries are significantly correlated
• Japan, Korea and Taiwan
• Hong Kong, Indonesia, Malaysia, and Singapore

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Yuens 2000 VAR study

• Sample of 10 East Asian countries for 1967-1997
• Suggests 3 set of groupings
• Singapore and Malaysia
• Japan and Korea
• Taiwan and Hong Kong

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Degree of Openness
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Trade Integration

• Bilateral Trade Table (Wyplosz)
• Major Trade Trends in East Asia-Francis Ng and
  Alexander Yeats (2003)

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International Factor Mobility
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Labor Mobility

• Eichengreen and Bayoumi (1996) Labor mobility in
  Asia, relatively high.
• Example, in Singapore, workers from Malaysia,
  Thailand, Indonesia and Philippines accounted for
  fully 10 of employment in the 1980s.
• The elasticity of supply of Chinese workers to HK
  is notoriously high.

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Argument

• Asia should be first divided into small
  clusters and then integrate into a larger
  currency area

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Obstacles
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Obstacles

• Different economic, cultural and financial
  structures
• Differences in the level of development
• Lack of political aspirations

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Criticism of OCA theory

• Endogeneity of certain OCA criteria some
  countries might not satisfy the criteria of
  joining monetary union, but can achieve them
  later in the future, hence, ex poste rather than
  ex ante.

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Is a Currency Area in Asia Possible?
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Eichengreen and Bayoumi (1996)

• East Asia lacks the political solidarity and
  cohesion to institutionalize a durable system of
  collective currency pegs.
• It is hard to believe that Beijing would permit
  other East Asian countries to mandate a change in
  Chinese macroeconomic policy as a quid pro quo
  for intervention in support of the renminbi, or
  that other countries would entrust Beijing with
  this authority in return for its support

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Mundell Does Asia need a common currency? 2002

• According to him, the answer depends on what the
  alternative to it is.
• If the alternative is the present system, then
  my answer is yes, Asia needs a common currency.
  If however, the alternative to it is a global
  currency, which I think would be the best
  solution, then my answer is Asia does not need a
  separate common currency.

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Brunei Singapore