Rethinking Optimum Currency Area in East and South-East Asia: New Empirical Evidence

Abstract

This paper evaluates the viability of a monetary union or optimum currency area (OCA) in East and South-East Asia. Previous studies have mainly focused on a single aspect of integration, which has led to contrary findings. We adopt several alternative approaches that cover fiscal, output, and price aspects to accomplish the objective. As the synchronization of business cycle is a key prerequisite for forming an OCA, we test the level of business cycle synchronization among the countries of this region. The results of synchronization testing appear favorable, thus, strengthening the argument for forming a monetary union. Our analysis also shows that the regional shock is a dominating factor determining output movements in these countries. Next, we use a generalized purchasing power parity (G-PPP) procedure to test the long-run interrelationship among bilateral real exchange rates. Our findings based on bilateral real exchange rates indicate that the vital macroeconomic variables that determine real exchange rates, such as trade, finance, and price movements, are highly associated in the region. We also find that the short-run adjustment speed is sufficiently large for most exchange rates, barring a few. Consequently, we show that most economies in the region are sufficiently integrated to form a monetary union at any time.