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The Possibility of a Common Currency in Southeast Asia: A Business Cycle Empirical Analysis

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Class : 20172018.Fundamentals of Macro-Economics

Assignment : Macro-Economic paper

Word Count : 1319 words

Date Submitted : 3 December 2017

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Student Name : Mahdiazhari Austian

Teacher Name : Wouter Zant, Makoto Watanabe, Vincent van den Berg
The Possibility of a Common Currency in Southeast Asia: A Business Cycle Empirical Analysis

The Possibility of a Common Currency in Southeast Asia: A Business Cycle Empirical


Mahdiazhari Austian


Fundamentals of Macro-Economics

3 December 2017

APA Style Formatting

The Possibility of a Common Currency in Southeast Asia: A Business Cycle Empirical Analysis


The 1997 Financial Crisis in Asia revealed the weakness of the exchange rate system
in the Asian region, especially the Southeast Asian region. Before the crisis, the countries in
Southeast Asia pegged their currencies to the United States (US) dollar (Shirono, 2008). As
the US recovered from a recession in the early 1990s, the US Federal Reserve Bank (FSB)
began to raise US interest rates to reduce inflation. The higher US dollar caused the exports
of Southeast Asian countries to become more expensive, thus becoming less competitive in
global markets. The growing exports of China was also considered to be a contributing factor
in the crisis.

In the wake of the crisis, one of the solutions that was formulated is the formation of a
Common Currency Area (CCA). Moreover, the Association of South East Asian Nations
(ASEAN), in their Hanoi Plan of Action in 1998 indicated that they will “Study the feasibility
of establishing an ASEAN currency and exchange rate system”(ASEAN, 2012). After the
introduction of the Euro common currency in 1999, more and more interest has sparked on
the topic of Optimal and Common Currency Areas for the ASEAN countries. The fact that it
is considered to have worked well over the years and is well received in Europe served to
grow this interest.

In response to the growing interest in CCAs, this paper aims to assess the feasibility
of a common currency in Southeast Asia, particularly the countries in ASEAN: Thailand,
Vietnam, Indonesia, Malaysia, Philippines, Singapore, Myanmar (Burma), Cambodia, Laos,
Brunei Darussalam. Firstly, the paper will present the analysis from the literatures regarding
the requirements for an Optimum Currency Area (OCA). Secondly, using existing research
and empirical results, it will be investigated whether countries in ASEAN fulfill the criteria
for an OCA. Due to length constraints, the analysis will only cover the business cycle criteria.
Finally, after analyzing the requirements and empirical results, the possibility of a common
currency in ASEAN will be determined. This paper is also relevant because the presence of a
common currency in ASEAN will surely boost trade and output in the region. Therefore, the
following research question is proposed: Based on the symmetry of business cycles of
ASEAN member countries, can the countries in the ASEAN region have a common
The Possibility of a Common Currency in Southeast Asia: A Business Cycle Empirical Analysis

Optimum Currency Area (OCA) Criteria

The OCA theory states a set of criteria, that if satisfied, would be optimal for the
countries to adopt a common currency (Mankiw & Taylor, 2014). The term optimal here
means that if the countries were to adopt a single currency, the benefits of it would outweigh
the costs. This theory, pioneered by Mundell (1961), catalogues these criteria:
symmetry/synchronization of demand shocks, high labor and capital mobility, and real wage
flexibility. These are considered the criteria that reduce the costs of a single currency
(Mankiw & Taylor, 2014). Mankiw & Taylor (2014) also stated that the other criteria, a high
degree of trade integration, is the one which increases the benefits of a common currency.

Symmetric Demand Shocks

As pointed out by the theory, one of the cost of a currency union is the loss of
independent monetary policy. If the demand shocks were asymmetric, so that it impacted
each member country differently, then they would require different short-run policy
responses. If countries react to shocks symmetrically, by having similar production structures
and react similarly to the global events, then there would be no problems as the common
monetary policy can also stabilize as good as the individual policies (Mankiw & Taylor,

Real Wage Flexibility

Having a high degree of wage flexibility means that adjustments to reach the
equilibrium of the long-run is very quick. In other words, the duration of the short-run change
is very short (Mankiw & Taylor, 2014). However, this criteria does not work in practice as
there exists no true wage flexibility (Mckinnon, 1988). Moreover, in the case of the European
Union, wage agreements between firms and workers often extends to the firm’s branch in
other countries. Because a single currency means more transparency in the case of wage
differences across countries, it causes firms difficulties to change wages in different

High Labor and Capital Mobility

If there is a high labor and capital mobility across countries, both inflation and
unemployment pressure would reduce without adjustments in the exchange rate. Labor
mobility causes workers to be able to respond to adverse shocks by moving across countries
The Possibility of a Common Currency in Southeast Asia: A Business Cycle Empirical Analysis

to obtain jobs. Capital mobility causes the recessionary economy to be able to obtain funds
from the booming economy, therefore insuring one another against asymmetric shocks
(Mankiw & Taylor, 2014).

High degree of Trade Integration

If a currency union is established, it would result in the reduction in transaction costs

and reduction of exchange rate volatility (Mankiw & Taylor, 2014). The greater amount of
international trade carried out between the members, the greater reduction in transaction
costs. Firms benefit from the reduction in exchange rate volatility because they will compute
their revenue with more certainty compared to the uncertainty associated with exchange rate

Empirical Evaluation of ASEAN CCA

Following the methods defined in Alesina & Barro (2002), the analysis will focus on
the criteria of business cycle symmetry (Alesina & Barro, 2002). Furthermore, this analysis
will use data after 1997 (After the Asian crisis) up to 2015 following the empirical results by
Vu (2017).

Symmetry of Business Cycles

To measure the symmetry of demand shocks, we will look at the economic cycle of
the ASEAN countries. The business cycle synchronization of the members is obtained by
computing correlations of bilateral business cycles of ASEAN members and the correlations
between each country and the business cycle of the whole ASEAN (Vu, 2017). The data was
computed from annual real GDP per capita, from 1998 to 2015 and is obtained from the
World Bank. Positive correlations mean the business cycle flows in the same direction while
a negative means opposite directions. The business cycles to be significantly synchronized if
the correlation coefficients are equal to or larger than 0.4 (with alpha/significance level of
0.05 or 5%). The data is compiled into table 1 (see appendix).

From the table, most of the cross-correlations are positive (forty-three out of forty-
five), only two are negative (Brunei-Myanmar with a coefficient of -0.46 and Indonesia-Laos
with a correlation of -0.09). Among the positive correlations, twenty-two out of forty-three of
them is larger than or equal to 0.40. The pairs of countries Malaysia-Singapore, Philippines-
The Possibility of a Common Currency in Southeast Asia: A Business Cycle Empirical Analysis

Cambodia, Philippines-Thailand, Malaysia-Cambodia, and Malaysia-Philippines exhibit high

correlations (0.7 and above).

To aggregate the business cycle of the whole ASEAN, real GDP per capita of
ASEAN from 1998 to 2015 is used and it is calculated by dividing the aggregate real GDP by
the total population of ASEAN. Prices are held constant at 2010 USD prices of all ASEAN
countries, the ASEAN population is the sum of all ASEAN countries’ population. The results
are summarized in table 2 (see appendix).

Out of the ten countries, nine countries show a positive and significant level of
synchronization with the Aggregate ASEAN cycle. Among them, Thailand, Singapore,
Philippines, and Malaysia exhibit high degrees of correlation with the aggregate ASEAN
cycle. Myanmar is the only country with business cycles not significantly correlated with the
ASEAN (only 0.3).


The correlation of economic fluctuations would not be an obstacle for ASEAN

countries to form a monetary union. Asides from one country, Myanmar, the remaining
countries show a statistically significant and positive correlation of business cycles with those
of the ASEAN. Moreover, it is also interesting to note that the five highest GDP countries in
ASEAN reveal the highest correlations of business cycles with the overall ASEAN business
cycle. From the Business cycle analysis, we can see that Myanmar would be the member
getting the ‘short end of the stick’ should ASEAN adopt a single currency, as it might be the
member with possibly the highest cost if the common currency is implemented.
The Possibility of a Common Currency in Southeast Asia: A Business Cycle Empirical Analysis


Table 1. Correlation of business cycles between ASEAN countries, 1998-2015

Source: Vu (2017) and World Bank
BRN = Brunei, KHM = Cambodia, IDN = Indonesia, LAO = Laos, MYS = Malaysia, MMR
= Myanmar, PHL = Philippines, SGP = Singapore, THA = Thailand, VNM = Vietnam.
Bold numbers are statistically significant and positive at a significance level of 5%.

Table 2. Correlation of business cycles with ASEAN business cycle

Source: Vu (2017) and World Bank
The Possibility of a Common Currency in Southeast Asia: A Business Cycle Empirical Analysis

Alesina, A., & Barro, R. (2002). Currency Unions. Quarterly Journal of Economics, 107(2),
ASEAN. (2012). Hanoi Plan of Action - ASEAN | ONE VISION ONE IDENTITY ONE
COMMUNITY. Retrieved December 1, 2017, from
Mankiw, N., & Taylor, M. (2014). Macroeconomics (2nd European ed.). New York: Worth
Mckinnon, R. I. (1988). Monetary and Exchange Rate Policies for International Financial
Stability: A Proposal. The Journal of Economic Perspectives, 2(1), 83–103.
Mundell, R. a. (1961). A Theory of Optimum Currency Areas. The American Economic
Review, 51(1775), 657–665.
Shirono, K. (2008). Real effects of common currencies in East Asia, 19, 199–212.
Vu, V. T. H. (2017). A monetary union for the ASEAN ? An empirical assessment.
Universidade do Porto.
indicators&preview=on# accessed December 2017