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A Bayesian Approach to Optimum Currency Areas in East Asia

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  • Grace H.Y. Lee
  • M. Azali

Abstract

This paper assesses the empirical desirability of the East Asian economies to an alternative exchange rate arrangement (a monetary union) that can potentially enhance the exchange rate stability and credibility in the region. Specifically, the symmetry in macroeconomic disturbances of the East Asian economies is examined as satisfying one of the preconditions for forming an Optimum Currency Area (OCA). We extend the existing literature by improving the methodology of assessing the symmetry shocks in evaluating the suitability of a common currency area in the East Asian economies employing the Bayesian State-Space Based approach. We consider a model of an economy in which the output is influenced by global, regional and country-specific shocks. The importance of a common regional shock would provide a case for a regional common currency. This model allows us to examine regional and country-specific cycles simultaneously with the world business cycle. The importance of the shocks decomposition is that studying a subset of countries can lead one to believe that observed co-movement is particular to that subset of countries when it in fact is common to a much larger group of countries. In addition, the understanding of the sources of international economic fluctuations is important for making policy decisions. Our findings also indicate that regional factors play a minor role in explaining output variation in both East Asian and the European economies. This implies that while East Asia does not satisfy the OCA criteria (based on the insignificant share of regional common factor), neither does Europe.

Suggested Citation

  • Grace H.Y. Lee & M. Azali, 2009. "A Bayesian Approach to Optimum Currency Areas in East Asia," Monash Economics Working Papers 18-09, Monash University, Department of Economics.
  • Handle: RePEc:mos:moswps:2009-18
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    File URL: http://www.buseco.monash.edu.au/eco/research/papers/2009/1809bayesianleeazali.pdf
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    References listed on IDEAS

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    1. Charles Wyplosz, 2001. "A Monetary Union in Asia? Some European Lessons," RBA Annual Conference Volume,in: David Gruen & John Simon (ed.), Future Directions for Monetary Policies in East Asia Reserve Bank of Australia.
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    Cited by:

    1. Hyun, Junghwan, 2016. "Financial crises and the evolution of credit reallocation: Evidence from Korea," Economic Modelling, Elsevier, vol. 56(C), pages 25-34.

    More about this item

    Keywords

    Optimum Currency Area; Business Cycle Synchronisation; Monetary Integration; East Asia;

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles
    • F1 - International Economics - - Trade
    • F4 - International Economics - - Macroeconomic Aspects of International Trade and Finance

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