Monetary Policy Synchronization in the ASEAN-5 Region: An Exchange Rate Perspective

Transcription

1 Moneary Policy Synchronizaion in he ASEAN-5 Region: An Exchange Rae Perspecive Punee Vasa Shell Canada Limied Calgary, AB T2P 2H5, Canada Subhash C. Sharma Deparmen of Economics Souhern Illinois Universiy Carbondale Carbondale, Il , USA and Hem C. Basne* Deparmen of Business and Economics Chadron Sae College Chadron, NE 69337, USA Augus 2014

2 Common Feaures Analysis of ASEAN-5 Exchange Raes and Is Economic Implicaions Absrac In ligh of he longsanding vision of economic and moneary inegraion in he ASEAN region and he imporance of coordinaing moneary policies o achieve i, he objecive of his paper is o he assess he moneary policy synchronizaion among he founding members of he ASEAN, i.e., Indonesia, Malaysia, Philippines, Singapore and Thailand. Due o he imporance of exchange rae movemens o he coordinaion of moneary policies, we approach his issue from a currency exchange rae perspecive. Specifically, mulivariae rend-cycle decomposiion is employed o invesigae common rends and common cycles among he exchange raes of hese counries during he period 1976 o Our analysis reveals ha he real exchange raes of Malaysia, Philippines, Singapore and Thailand share common cycles in he shor erm and have common rends in he long erm, bu he Indonesian currency does no share hese relaionships. Thus, our resuls augur well for he synchronizaion of moneary policies among Malaysia, Philippines, Singapore and Thailand. In conras, he relaively urbulen dynamics of he Indonesian Rupiah eviden in frequen bous of sark depreciaion separaed by periods of seady depreciaion over he pas hree decades raise quesions regarding he readiness of Indonesia for paricipaing in a moneary alliance wih he ASEAN-4 naions. JEL Classificaion: F31, F33, F36 Key words: exchange rae, common feaures, moneary union, ASEAN 2

3 Common Feaures Analysis of ASEAN-5 Exchange Raes and Is Economic Implicaions I. Inroducion The ASEAN-5 economies 1 have araced a considerable amoun of aenion from invesors, policy makers and researchers over he pas wo decades. This region has experienced ousanding economic growh which has been referred o as he Eas Asian Miracle, and is of ineres o boh researchers and policymakers. The ASEAN-5 economies rely heavily on rade. They rade exensively among hemselves as well as wih counries ouside he ASEAN region. The rade-o-gdp raios illusrae he degree of openness of hese economies. In one year before he Asian financial crisis - Indonesia, Malaysia, Philippines, Singapore and Thailand had rade-o-gdp raios of 0.52, 1.82, 0.90, 2.78 and 0.85 respecively 2. Also, he inra-asean foreign direc invesmen (FDI) flows have experienced asonishing growh. According o he ASEAN Invesmen Repor 2011, FDI inflows grew approximaely by 105% in 2010, and expeced o grow as he region coninues o hrive like in recen years. In 2010, each of he five counries recorded an economic growh of 6%. I is believed ha he sabiliy of inraregional exchange rae will help promoe rade, invesmen and growh among counries wih similar rade composiion (Kawai, 2008; Bhandari and Upadhyaya, 2010) To complemen he fusion of rade and finance, poliical harmony is also brewing in he ASEAN region. Encouraged by hese developmens, he ASEAN leaders are considering he possibiliy of an ASEAN Moneary Union. Significan seps have been aken owards a greaer inegraion in he pas wo decades. A ASEAN summi 1998, he heads of he sae agreed o form a ask force o conduc a sudy on he feasibiliy of an ASEAN currency union. Subsequenly, several breakhroughs such as he 1 ASEAN-5 economies refer o he economies of he founding members of he Associaion of Souheas Asian Naions-Indonesia, Malaysia, Philippines, Singapore and Thailand. 2 The rade-o-gdp raios have been calculaed by dividing he sum of expors and impors by GDP. 1

4 esablishmen of he Chiang Mai Iniiaive 3 (CMI) in Eas Asia s effors owards moneary cooperaion ook place (Sun and Simons, 2011). Addiionally, he ASEAN naions are seadily progressing owards he formaion of he ASEAN Economic Communiy (AEC) which envisions enhanced inra-regional economic inegraion and seeks o esablish he ASEAN region as a single marke, hus making i more compeiive and efficien. In fac, he esablishmen of he ASEAN Free Trade Area (AFTA) is well on is way. The signing of he ASEAN Comprehensive Invesmen Agreemen (ACIA) in February 2009 was a big leap forward owards he creaion of an open and a desegregaed invesmen zone. Such inraregional agreemens manifes he desire of he ASEAN counries o form a comprehensive economic alliance, which upon compleion is likely o make he ASEAN region an economic force o reckon wih on he global economic plaform. The surge in inra-regional rade has been an imporan source of economic growh for he ASEAN-5 naions. These counries also caer o he impor demands of developed counries such as Japan, he US, and members of he European Union. The exisence of common rading parners fosers a compeiive environmen among he ASEAN-5 naions. The desire o arac boh inra-regional and exra-regional foreign direc invesmen - anoher engine for economic growh - from common desinaions, mos noably Japan, he US, he UK and he Neherlands only elevaes he degree of compeiion among he ASEAN-5 naions. Thus, resoring o he socalled beggar-hy-neighbor policies is no enirely inconceivable in such circumsances. For insance, hese policies may ake he form of driving he value of he domesic currency downwards o simulae expors which in urn may hur he expor secor of a compeing naion. Mainaining low raes of inflaion is anoher way o keep a counry s expors compeiive. Whereas his is enirely consisen wih he fundamenal moneary policy objecives of he ASEAN-5 naions i.e. mainaining price level sabiliy, his ofen involves currency appreciaion. 3 For he elaboraive ask assigned o CMI, please see Sun and Simons (2011). 2

5 Wih a large proporion of inra-asean rade aking place in he manufacuring secor, he appreciaion of a currency may ransfer cos-inflaion o he rading parners, hereby making heir expor secor less compeiive. Such economic spillovers no only weaken he cause of forming an economic alliance, bu also necessiae synchronizaion and coordinaion of moneary policies. In ligh of he ongoing effors owards moneary inegraion, his sudy inends o invesigae he wo common feaures i.e. long erm rends and shor erm cycles among he real exchange raes of he founding members of ASEAN Indonesia, Malaysia, Philippines, Singapore and Thailand in an effor o infer he feasibiliy of moneary inegraion. In his effor, he presen sudy paricularly aims o idenify i) he number of common rends, ii) he number of common cycles, iii) decomposes he original series ino is rend and cyclical componens, and finally analyze wheher or no here is a comovemen in he rend and cyclical componens. The cenral quesion of his sudy is, Is he exchange rae behavior among he ASEAN counries over ime similar enough o suppor forging an alliance for moneary union? Some sudies sugges ha counries should no creae a moneary union in he presence of large asymmeric (counry specific) shocks as he cos of having a moneary union would significanly ouweigh he benefis from i (Bayoumi, Eichengreen and Mauro, 2000; Sao and Zhang, 2006; Ahn, Kim and, Chang, 2006; Corinhas, 2009; Basne and Sharma, 2013).The chief implicaion of his sudy is ha if he exchange raes of he ASEAN-5 counries have boh common rend in he long erm and share common cycles in he shor erm hen hese counries can make he case for moneary inegraion. Equivalenly, if he exchange raes of hese counries are subjec o asynchronous rends and cycles hen forging a moneary union would be undesirable. The raionale for using exchange raes as he indicaor of he feasibiliy of a moneary union is ha for decades, he exchange raes dynamics has been in he core of moneary policy discussion in emerging marke economies as i is a crucial ransmission channel of moneary policy. In an open economy, a cenral bank uilizes he exchange rae as a shock absorber (hrough appreciaion/depreciaion). Furhermore, exchange rae movemens are cenral o inernaional 3

6 rade and finance as hey direcly impac he relaive price of goods and services in domesic and foreign markes. Flucuaions in exchange raes can have a significan bearing on he erms of rade and he value of foreign asse holdings since hey can poenially ransmi economic shocks across counries. Wilson and Choy (2007) noe ha he long and shor-erm dynamics of exchange rae play a decisive role in making he decision for a moneary union or opimum currency area. The growh of economic inegraion means ha policymakers need o be more aenive o he implicaions of foreign policies as he ransmission of economic disurbances via exchange raes (among oher media) from one counry o anoher may compromise he moneary auonomy of an economy. Thus, an examinaion of exchange rae co-movemens can provide useful insighs ino he issue of economic and financial spillovers. Also, he invesigaion of he longerm and he shor-erm co-movemens among he ASEAN-5 currency exchange raes is imporan due o he prospecs of moneary inegraion in he ASEAN region and he creaion of an Opimum Currency Area o faciliae rade and developmen. To he bes of our knowledge, no sudy has explicily addressed he common rend and common cycles in he exchange raes of ASEAN counries in conjuncion wih moneary inegraion. Noe ha he effec of exchange raes on macroeconomic sabiliy is linked o ineres raes, and oher imporan macroeconomic variables such as oupu and inflaion. While esing he dynamics behavior of exchange rae consiues a differen aspec of invesigaion in assessing he appropriaeness of a moneary union, we are aware ha an issue of his imporan (i.e. moneary union) should be evaluaed horoughly uilizing oher macroeconomic fundamenals ha include business cycle similariies, labor mobiliy, price and wage flexibiliy and finally poliical agreemens. To ha exen, his sudy does no provide a horough evaluaion for ha possibiliy. Half a cenury ago, Mundell (1961) inroduced he opimum currency area heory (OCA). Mundell and he proponens of moneary union claim ha a common currency faciliaes rade, reduce boh he risks associaed wih exchange rae uncerainy, and foreign exchange raes relaed ransacion coss. I also eliminaes he need for reserves for foreign ransacion. On he oher hand, he opponens of 4

7 common currency argue ha a counry joining a moneary union loses is moneary policy sovereigny ha is, he counry canno change he price of is currency a he ime of need, especially o couner counry specific macroeconomic shocks. The main findings of his paper are as follows. The real exchange raes of Malaysia, Philippines, Singapore and Thailand have a leas wo common rends in he long erm and do share he same number of common cycles in he shor erm. However, he Indonesian currency does no share his relaionship. The decomposed series (i.e. rend par and cyclical par) demonsrae a high degree of comovemen wih a posiive relaionship boh in he long and he shor run. Likewise, he correlaion coefficiens of boh rend and cyclical componens are srongly posiively relaed; none of he counries (excluding Indonesia) share a negaive relaionship. The organizaion of his paper is as follows. In secion II, relevan lieraure is presened, secion III includes he daa and mehodology used in his sudy. The empirical findings are discussed in secion IV and Secion V concludes his aricle wih he main findings and policy implicaions. II. Brief Lieraure review: There is a growing lieraure ha empirically invesigaes he prospec of moneary union or opimum currency area (OCA) in Eas Asian counries in general or ASEAN-5 in paricular. In a recen paper, Rhee (2012) ess for he possibiliy of a moneary union in he ASEAN +3 (Souh Korea, China and Japan) by uilizing he GARCH-M model and concludes ha he prospec of moneary union is no in place. In conrary, Binner e al. (2011) find he favorable condiion for opimum currency area in ASEAN plus Taiwan. Their resuls asser ha hese counries mee necessary condiions for forming a common currency area. Chin and Azali (2010) examine he linkages among he ASEAN-5 currencies during pre and pos crisis. Their resuls show ha here was no coinegraing relaionship during he pre-crisis period, bu a meaningful coinegraion exiss during he pos crisis period suggesing a low financial inegraion among he ASEAN-5 before he crisis. 5

8 Sun and Simons (2011) invesigae he feasibiliy of moneary union in eleven Eas Asian counries ha include ASEAN-5. Their coinegraion and he Granger causaliy es resuls do no suppor a uniform moneary union incorporaing all eleven counries. The sudy, however, finds some supporive evidence for a sub-group union such as beween Souh Korea, he Philippines, Thailand, Indonesia, and Malaysia. Corinhas (2009) invesigaes he suiabiliy of moneary inegraion in he ASEAN-5 by examining he exchange rae pass hrough ino domesic prices. The resul suppors a moneary union beween Singapore, Thailand and Malaysia. Indonesia and Philippines seem o be a weak candidae o join he union. Tawadros (2008) ess he endogeneiy of he opimum currency areas for ASEAN and concludes ha hese counries are no ye synchronized enough o enjoy he benefis of moneary unificaion. Similarly, Kim (2007) does no see any prospec of moneary union in Eas Asia excep a feeble possibiliy beween Hong Kong and China. Srobel (2007) also does no find any supporing evidence for he readiness of moneary union among he ASEAN group. By using he heory of Generalized Purchasing Power Pariy (G-PPP), Wilson and Choy (2007) do no find supporive evidence for an OCA for ASEAN-5. Ahn, Kim and Chang (2006), on he oher hand, provide evidence ha ASEAN-4 (excluding Philippines) and four Norheas Asian economies (Hong Kong, Japan, Souh Korea and Taiwan) may form an opimum currency area. Sao and Zhang (2006) es real oupu variables o assess he suiabiliy of moneary union in Eas Asia and find evidences for a pair of counries union bu no for he whole region. The exising evidence is mixed and inconclusive regarding wheher he ASEAN counries are ready for a coheren moneary union. Many sudies (see e.g. Binner e al. 2011; Tawadros, 2008; Kim, 2007) have invesigaed he feasibiliy of a moneary union in ASEAN counries by uilizing eiher G- PPP, VAR or he coinegraion framework. This sudy differs mehodologically because i uilizes he serial correlaion common feaures es proposed by Vahid and Engle (1993). The es develops a muli counry framework o idenify common rends and common cycles. Addiionally, he common feaure es decomposes he original series ino wo pars (rend and cyclical componens) and analyze heir 6

9 relaionship 4. The rend par explains he long run relaionship while he cyclical par shows he relaionship in he shor run. An examinaion of he long-erm and shor-erm exchange rae dynamics will reveal he following informaion for he benefi of he moneary auhoriies in ASEAN-5. Firs, he sudy will provide he ASEAN-5 naions imporan insighs abou heir exchange raes movemen boh in he long and shor run, which may enhance furher dialogue in he region for moneary union. Second, i will shed ligh on he exen of he auonomy and he degree of insulaion of moneary policies o economic shocks occurring in foreign naions. Third, he ransiion period he period in which a counry is in he process of giving up he use of is currency in favor of he common currency can be relaively smooh if heir exchange rae markes have exhibied co-movemens hisorically, boh in he long-run and in he shor-run. In oher words, i is relaively easy o inegrae markes ha have exhibied inegraion in he pas. As Grimes (2005) poins ou ha he moneary auonomy of counries will no be compromised much as a resul of moneary inegraion if hey have synchronous cycles. In addiion o benefiing o he policy dialogue, our resuls also benefis he invesors. For insance, if wo or more exchange raes share common rends, hen long-run benefis arising from diversifying a foreign invesmen porfolio among he corresponding currencies will be miigaed. The shor-erm cycles have implicaions on gains from diversifying foreign invesmen porfolios over shorer invesmen horizons. Invesors seeking shor-erm invesmen gains can benefi from monioring ransiory or shor-erm responses of exchange raes o various economic and financial shocks. For 4 Iniially, Vahid and Engle (1993) examined he presence of common rends and common cycles among per capia consumpion and income, and Engle and Issler (1993) invesigaed rend-cycle decomposiion among per capia GDP of Argenina, Brazil and Mexico, and laer Engle and Issler (1995) examined he presence of rend and cyclical componens among he oupus of various secors of he U.S. Recenly a number of researchers (e.g. Bein, Candelon and Hecq (2000), Sharma and Wongbangpo (2002), Sao and Zhang (2006), Sao, Allen and Zhang (2007), Abu-Qarn and Abu-Bader (2008) and Adom e al. (2010), Basne and Sharma (2013b) among ohers) have used he common rend and common cycle approach among a se of macro variables o invesigae he feasibiliy of a moneary/economic union in a group of counries. Adom e al. (2010) have given a deailed jusificaion as o how his mehodology is superior o he one proposed by Blanchard and Quah (1989) and used by researchers earlier. 7

10 insance, ceeris paribus, he depreciaion of a currency causes he value of he asses denominaed in ha currency o decline as well. III. Daa and Mehodology Daa We use monhly daa on nominal exchange raes expressed in erms of he domesic currencies of Indonesia, Malaysia, Philippines, Singapore and Thailand - per US Dollar from January 1976 o April The daa are obained from he Inernaional Financial Saisics CD-ROM. The real exchange series are consruced as follows: r i e i, p p *, where e i, is he US Dollar price of he currency of counry i, p and p are he consumer price index of he US and home counry respecively. There was a financial urmoil in he exchange raes of he ASEAN-5 naions beginning from July 1997 unil Sepember We have specifically included he urmoil because he inclusion of his period allows us o sudy he sample period in is enirey, and also can be used o demonsrae he financial conagion during he Asian financial crisis 5. Mehodology Firs, all he exchange rae series are esed for saionariy and heir order of inegraion is deermined. We employ he Dickey-Fuller (1979) and he augmened Dickey-Fuller (1981) ess, he Phillips-Perron ess [Phillips and Perron (1988), Perron (1988)] and he KPSS es [Kwiakowski, Phillips, Schmid and Shin (1992)] o es for uni roos in he individual ime series. Afer deermining heir order of 5 In he conex of he 1997/98 financial crisis in Eas Asia, researchers have uilized a variey of ways (such as providing pre and pos crisis esimaions (Wilson and Choy, 2007), or using a dummy variable (Sun and Simons, 2011) or using enire period wihou any breakdown or so (Rhee, 2012) ec.) o deal wih a srucural change issue caused by he crisis. In an aemp o ake care of his issue, we re-esimaed he model B by excluding he fifeen monh (July 1997 o Sepember 1998) of he crisis period. However, we did no find any qualiaive differences in he resuls. One of he goals of his sudy is o invesigae wheher or no he ASEAN counries demonsrae he comovemen in heir rend and cyclical componens during he crisis period. Therefore, only he resuls of whole period are repored; he resuls of he excluding period are no repored in he paper, are available upon reques hough. 8

11 inegraion, he opimum lag-lengh o be used in he coinegraion model is idenified by conducing he sequenial likelihood raio ess on he unresriced vecor auoregression models consising of he levels of he naural logarihmic ransformaions of he five exchange rae series. We use he maximumlikelihood based λ-max and λ-race saisics proposed by Johansen (1988, 1991) o es for he number of coinegraing vecors among he spo exchange raes of he ASEAN-5 counries. Johansen demonsraed n 1 ha given an vecor x, here can exis r n linearly independen coinegraing vecors implying n r r n he presence of common rends. The marix is he marix of he coinegraing coefficiens and ' x is I(0). We consider he following model: Model A: x e, e, e, e, e IDR MYR PHP SGD THB where x is a ( 5 1) vecor and e, e, e IDR MYR PHP, e SGD and THB e are he naural logarihmic ransformaions of he real exchange raes of he Indonesian Rupiah, he Malaysian Ringgi, he Philippine Peso, he Singapore Dollar and he Thailand Bah respecively. The likelihood raio ess proposed by Johansen (1988, 1991) are also used o es he saisical significance of each of he coinegraing coefficiens by imposing resricions wihin he esimaed coinegraing vecor. According o Vahid and Engle (1993), he number of common cycles can be deermined by esing he significance of he co-feaure vecors ( i. e. canonical correlaions) among x and ' x, x, x, x 1 1 2, m 1 where m is he chosen lag-lengh of he vecor auoregression model. Vahid and Engle (1993) proposed a χ 2 saisics o es for he number of significan co-feaure vecors. However, following Engle and Issler (1995), here we use an F-es approximaion discussed in Rao(1973), since his F-es has beer small sample properies han he χ 2 saisics. Vahid and Engle (1993) noed ha wih r linearly independen coinegraing vecors, if x has common cycles, here can, a mos, exis n r linearly independen cofeaure vecors ha eliminae common cycles. In oher words, if here exiss r (< n) linearly independen co-inegraing vecors, here 9

12 can exis a mos s ( n r) linearly independen cofeaure vecors and ( n s) common cycles. The range of he n s marix ~ is referred o as he cofeaure space. Also, here exiss linear independence among he r coinegraing vecors and he s cofeaure vecors. They demonsraed ha he necessary condiion o recover he rend and cyclical componens of he series is ha he sum of he linearly independen coinegraing vecors and he linearly independen cofeaure vecors is exacly equal o he number of variables, i.e. r s n. If r s n n n hen a marix ~ ' B ' is of full rank and hus 1 B exiss. Upon pariioning he columns of 1 B i.e., ~ 1 B [ ], he rend and cyclical componens can be recovered in he following way 6 : x 1 B B x ~ ~ ' x ' x Trend Cycle (1) We know ha ' x is serially correlaed and I(0). Therefore ' x represens he cyclical componen. On he oher hand, ~ ' x is a random walk and does no conain any cycles. Therefore, ~ ~ ' x represens he rend componen. IV. Empirical Resuls Following he lieraure, all he exchange rae series are ransformed ino heir naural logarihmic forms. The uni roo ess discussed in he earlier secion are used and hese es saisics are presened in Table 1. The uni roo es saisics reveal ha each of he five real exchange rae series is I(1). [Table 1 here] Trend-Cycle Decomposiion Based on he sequenial likelihood raio es, six lags are idenified as he opimum for he co-inegraion model. In order o deermine he model specificaion, we es he null hypohesis of a model wih no 6 This decomposiion is explained in deails in Vahid and Engle (1993, pp ). 10

13 inercep and no rend agains he alernaive hypohesis of a model wih an inercep and no rend. We rejec he null hypohesis a he 5 % significance level as he likelihood raio, 2 (1) = 6.92 > Thus, a model wih an inercep erm and no rend is chosen for he analysis. Boh he λ-race and he λ-max saisics reveal (Table 2) he presence of one coinegraing vecor. The Lagrange muliplier (LM) χ 2 saisics o es for no-auocorrelaion among he residuals (wih 25 d.f.) is wih a p-value of Thus, he residuals of model A are whie noise. Nex, he saisical significance of each of he five variables is esed using he likelihood raio saisics by imposing resricions H o : 0 k where k = 1, 2 5 wihin he coinegraing vecors. The es saisics in Table 3indicae ha he Indoneisan Rupiah is no significan (p = 0.49) and herefore, can be excluded from he model. [Table 2 here] The overwhelming saisical evidence o he exclusion of he Indonesian Rupiah can be explained in large par by is raher unique dynamic behavior - wihin he conex of ASEAN-5 exchange raes - before, during and afer he Asian financial crisis in Alhough, he Indonesian Rupiah was officially pegged o an undisclosed baske of currencies beween 1978 and 1997 (Reinhar and Rogoff, 2002), Indonesia did no possess he macroeconomic fundamenals ha play a key role in mainaining a currency peg. I was plagued by several banking, financial and poliical crises. Also, among he ASEAN-5 currencies, he Indonesian Rupiah experienced he mos severe devaluaions during and before he Asian financial crisis. No only were hese insances of devaluaion relaively more severe, he frequency of such insances of sark devaluaions was relaively high. Moreover, during he periods separaing such insances, he Indonesian Rupiah coninued o depreciae a a gradual rae. Such behavior was no exhibied by any of he oher four currencies during he pre-crisis period. The Rupiah depreciaed by approximaely 50% in November 1978 when i severed is link o he US Dollar. The Indonesian financial secor had operaed under sric regulaory laws during he 1970s. In he wake of financial reforms underaken o deregulae he financial secor, he Rupiah depreciaed by 37.8% in April Following his period, he Rupiah gradually depreciaed agains he US Dollar unil Sepember The 11

14 Rupiah was devalued by anoher 44.26% in Sepember As menioned above, during he Asian financial crisis - from June 1997 o January he Indonesian Rupiah suffered a devaluaion of 265%. In he pos-crisis period, he Indonesian Rupiah is he only currency among he ASEAN-5 currencies ha has no exhibied a clear appreciaing rend agains he US Dollar. The currencies of Thailand and Singapore have seadily appreciaed agains he US Dollar since 2003 and he currencies of Philippines and Malaysia have done he same since [Table 3 here] Such dynamics coupled wih he overwhelming saisical evidence warran he exclusion of he Indonesian Rupiah from he model. Therefore, we esimae he following resriced model, Model B o deermine he presence of common rends and cycles among he remaining four exchange raes: Model B: x e, e, e, e MYR PHP SGD THB The idenical mehodology is employed o he resriced Model B as was employed o he unresriced Model A in order o deermine he opimum lag-lengh and he number of co-inegraing vecors. The likelihood raio es reveals a lag-lengh of six. A model wih an inercep and no rend is uilized as he χ 2 saisics (i.e. 5.84) rejecs he null hypohesis of a model wih no inercep and no rend a he 5% significance level. The resuls of he coinegraion es for model B are repored in lower panel of Table 2. We canno rejec he null hypohesis of wo coinegraing vecors a he 5% significance level. While he -race indicaes only one coinegraing vecor (i.e. r =1), he max saisics reveal he presence of wo co-inegraing vecors among he ASEAN-4 exchange raes. We use he es resuls from max as i has a more definiive alernaive hypohesis (Enders 1995, p393). The exisence of wo coinegraing vecors (i.e. r =2) implies ha here exiss wo (n r: 4-2 = 2) common rends. The presence of common sochasic rends among exchange raes has long-run implicaions on he behavior of hese raes, i.e., while hey may drif apar emporarily hey will evenually be brough ogeher by heir 12

15 common sochasic rends 7. The LM χ 2 saisics o es for no-auocorrelaion among residuals is 8.32 (wih 16 d. f.) wih a p-value of 0.93 and hus reveals ha he residuals are whie noise. [Table 4 here] Once he long erm co-inegraing relaionship is esablished he nex sep is o es for he number of common cycles. For ha, we conduc he serial correlaion common feaure es proposed by he Vahid and Engle (1993), which has been discussed in secion 3.2. The es resuls are repored in Table 4. The null hypohesis ha he rank of he cofeaure vecors (s) is four is rejec a he 5% significance level. The es saisics presened in Table 4 sugges ha he real exchange raes of ASEAN-4 has wo cofeaure vecors (i.e. s =2), implying ha hey share a leas wo common cycles. Noe ha he number of coinegraing vecors (r) deermine he number of common rends and he number of cofeaure vecors (s) deermine he number of common cycles. In his sudy, he common feaure es idenifies wo coinegraing vecors (r =2) and wo cofeaure vecors (s =2), which leads o our final ques of rend-cycle decomposiion. Since we have r + s = n (i.e. r =2, s= 2 & n =4), he special condiion suggesed by he Vahid and Engle (1993), is saisfied and herefore we decompose he exchange rae series ino heir rend and cyclical componens using equaion (1). The decomposed series are uilized o measure he degree of comovemens boh in he long and shor run. Cofeaure Analysis The resuls asser ha he four ASEAN counries have wo common rends and share he same number of common cycles in heir exchange raes. To furher analyze he dynamics of he long and shor erm commonaliies, each series is decomposed ino is rend and cyclical componens by using equaion (1). The long-erm rends of all four counries are ploed in Figure 1. The cyclical componens are ploed in Figures 2. We observe ha he rend componens of all four counries exhibi a greaer degree of co- 7 However, he exisence of co-inegraing relaionship does no imply ha he counries under consideraion does no differ in heir policy implemenaion over ime. A bes, i simply means ha any deviaion in he shor run will be correced by inernal dynamics ha pushes hese economies back owards equilibrium pah in he long run (Darra and Al-shamsi, 2005). 13

16 movemen (Fig 1). The evoluion of rend componens wih respec o iming and impac is srongly similar among all four counries. Table 5, lower riangle, repors he correlaion coefficiens among he rend componens. The idea of esimaing he correlaion coefficiens is o measure he srengh of he associaion beween wo variables. The esimaed magniude and he direcion of he coefficiens sugges ha he rend componens of he ASEAN counries are highly posiively correlaed (Table 5, lower riangle). Noe ha he rend componens are obained by subracing he cyclical componens from he original series. The graphical presenaion furher assers he srong correlaion. The correlaion beween Malaysia and Thailand, beween Singapore and Philippines, and beween Thailand and Philippines is 0.90 or more. While he correlaion beween Malaysia and Singapore, and beween Thailand and Singapore is 0.45 and 0.72 respecively, none of he counries share a negaive relaionship in heir componens. The sandard deviaion of he rend and cyclical componens presened in lower panel of Table 5 indicaes ha here is no noiceable cross counry differences in volailiy. The sandard deviaion of rend componen is very low; i is less han 1 for all four counries. In fac, i is only 0.10 for he mos volaile counry (Malaysia). [Table 5 here] In figure 1, we observe some noiceable insances. Firs, here is a sharp increase in rend componens of four counries during he 1980s and he lae 1990s, which coincides wih he Lain American crisis, and he Asian financial crisis respecively. In1982, Mexico along wih oher Lain American counries, faced a profound financial crisis, defauled on is foreign deb. Foreign invesors viewed he Lain American crisis as a general phenomenon in emerging markes ha hi he financial secor of he ASEAN naions as well. The shaded area in he 1980s in Fig 1 shows ha all four counries suffer a large devaluaion in heir real exchange raes. The second one is he big spike in he lae 1990s, which can be aribued o he Asian financial crisis. During he lae 1980s and early 1990s he Souh Eas (SE) Asian counries (ha includes he sample counries in his sudy) grew a an unprecedened level, which is ofen ermed The Asian Miracle. The SE Asian counries experienced an invesmen boom in 14

17 commercial and residenial propery, among ohers. Capial flows, mosly shor erm invesmen, from abroad increased significanly. However, foreign crediors and invesors began o sense he vulnerabiliy of banking secors when he banks, in many insances, failed o mee heir shor erm obligaions. A credior s panic eruped; he credior became relucan o roll over heir shor erm loan and invesors began o furher speculae ha hese counries may plunge ino a deep financial crisis. They pulled ou heir invesmens abruply. Firs, Thailand s domesic insiuions failed o mee heir exernal shor-erm obligaion. Evenually, he whole episode ended up being a complee financial meldown. The financial collapse caused he Thai currency o depreciae sharply. The meldown was so conagious and quickly spilled over he res of he counries. All four counries suffered almos he same level of currency depreciaion, which has been capured by a large spike in he rend componens during he ime of All major evens seem o be impacing ASEAN-4 counries in a very similar way ha suggess ha he region is prone o conagious effecs. Figure 1 assers ha he long erm behavior of he ASEAN-4 exchange raes shows srong similariies in erm of macroeconomic responses o inernal and exernal shocks. [Figure 1 here] Now urn o he behavior of he cyclical componens, ploed in Figure 2. We noe ha he cyclical componens of he Thai Bah, he Malaysian Ringgi, he Philippines Peso, and he Singapore Dollar exhibi a srong co-movemen and share a posiive relaionship, i.e., hey move ogeher in he same direcion. All four counries demonsrae very similar response o he major wo insances menioned above in he shor run as well. However, he ampliude of he Thai Bah is less pronounced compared o he res of he hree counries. The correlaion for cyclical componens reveals ha he cyclical behavior of he four counries is highly correlaed (Table 5 upper riangular). The correlaion among hem is above 0.80 for any pair of counries. In fac, he es resuls reveal ha he shor run behavior of he real exchange rae beween Malaysia and Singapore, beween Malaysia and Thailand, and beween Thailand and Singapore is perfecly correlaed (Table 5 upper riangular). The sandard deviaion 15

18 of cyclical componens corroboraes he perfec correlaion. The sandard deviaion for all counries is exremely low (Table 5 lower panel), suggesing a synchronized shor run movemen. This sudy does no find any inverse relaionship beween he rend and cyclical behavior. For insance, in a sudy of seven Lain American counries Basne and Sharma (2013) repor ha Argenina and Venezuela behave oally opposie han ha of he oher five counries Brazil, Chile, Colombia, Mexico and Peru. Therefore, he quie similar rend and cyclical behavior among he real exchange raes of ASEAN-4 counries sugges a synchronous policy response o he shocks. The similar response of boh rend and cyclical componens o he exchange rae flucuaions sugges a very similar macroeconomic fundamenals among he ASEAN -4 counries. [Figure 2 here] According o convenional lieraure highly correlaed business cycles are considered o be, among ohers, a necessary condiion for a higher level of economic or moneary inegraion. The idea behind his logic is ha if he business cycle flucuaions are no synchronized, hen harmonized fiscal or moneary policies could be undesirable. In ha case, each member requires differing se of policy prescripions o cope wih such asynchronous cycles. In ligh of synchronized long erm movemen among he real exchange raes of he ASEAN-4, i is worh menioning some of he forcing variables (i.e. fundamenals) ha may have driven he real exchange raes o a synchronized pah. The OCA heory emphasizes he role of real exchange rae as a sabilizaion insrumen. The link beween exchange raes and macroeconomic sabiliy is derived from ineres rae, and oher imporan variables such as oupu and inflaion. Enders and Hum (1994) argue ha if he forcing variables share common sochasic rends hen he real exchange raes ha are influenced by hese variables also share common rends. Thus, i is fair o say ha he macroeconomic fundamenals in he ASEAN-4 share commonaliies in responding o inernal and exernal shocks in he long erm. 16

19 Exchange raes in he shor-run may be influenced by currency flows iniiaed by invesors, poliical policies and ineres rae differenials arising due o fiscal and moneary shocks. However, significan foreign exchange inervenions by moneary auhoriies in order o preserve or aler he value of he currency may considerably impac he pah of he exchange rae. In recen years, he ASEAN naions have conduced moneary policies wih he primary objecive of mainaining price level sabiliy. In fac, Philippines (since January 2002) and Thailand (since May 2000) have adoped inflaion argeing moneary policy frameworks. Despie he esablishmen of inflaion argeing as he cornersone of moneary policy, he cenral banks of hese counries coninue o manage is currency exchange raes hrough inervenion in he foreign exchange rae marke (Ponines and Siregar, 2009) 8. While Malaysia and Singapore do no arge explicily saed rae of inflaion, price level sabiliy is indeed he overarching goal of heir moneary policy. However, exchange rae managemen has been and coninues o be imporan o he conduc of moneary policy in boh Malaysia and Singapore. The exisence of long erm common rend and shor erm common cycles in a se of variables respecively indicaes ha hose variables do no swing for long ime, hey ulimaely move ogeher, and share similar cyclical flucuaions in he shor run. Also, he shor-erm responses o shocks canno be separaed from macroeconomic condiions ha prevail in he counries. Wihin he economies of he ASEAN naions, he economies of Malaysia, Philippines, Singapore and Thailand have relaively sound economic fundamenals. These economies have well developed capial markes, have mainained low raes of inflaion and have successfully implemened financial and economic reforms leading o macroeconomic sabiliy. The relaively sable and invesor friendly financial and economic sysems may have 8 We are no suggesing ha he objecive of exchange rae sabiliy is necessarily inconsisen wih ha of price level sabiliy. 17

20 provided a safe and secure environmen for foreign invesmens. Thus, he srong similariy in he long run behavior migh have linked o a common facor ha may have caused he synchronous movemen in he long run. A plausible common facor ha migh have ied all counries ogeher could be moneary policy arge and macroeconomic condiion oulined above. Likewise, he quie similar cycles sugges ha he counries may have policy coordinaion hrough he channel of marke forces in he shor run. Therefore, our resuls suppor for a coheren moneary union a leas from he exchange raes movemen perspecive. V. Conclusions The ASEAN naions are keenly pursuing he goal of economic and moneary inegraion. Their inen is eviden in he enacmen of various economic and poliical agreemens ha seek o enhance inra-regional policy coordinaion. Our sudy explores an imporan aspec of moneary policy synchronizaion, i.e., currency exchange rae co-movemens. We find ha he currency exchange raes of he ASEAN-5 naions - wih he excepion of Indonesia - exhibi co-movemen in he long-run and in he shor-run. This resul bodes well for moneary policy coordinaion among hese counries. We isolae and idenify he rend and he cyclical componens of he Malaysian Ringgi, he Philippine Peso, he Thailand Bah and he Singapore Dollar in a mulivariae modeling framework inroduced by Vahid and Engle (1993). This allows us o examine he responsiveness of he ASEAN-4 exchange raes o ransiory and permanen shocks. I also allows us o examine he degree of shor-erm as well as long-erm co-movemens among he ASEAN-4 exchange raes. Our analysis reveals ha he exchange raes of Malaysia, Philippines, Singapore and Thailand have shared common rends and do share a leas wo common cycles bu he exchange rae of Indonesian Rupiah is no he par of long erm rend. The relaively urbulen dynamics of he Indonesian Rupiah eviden in frequen bous of sark depreciaion separaed by periods of seady depreciaion over he pas hree decades raise quesions regarding he readiness of Indonesia for paricipaing in a moneary alliance. Our resuls sugges ha he real exchange rae of ASEAN-4 canno deviae from he long run equilibrium for a long ime, hey ulimaely move ogeher and hey share similar cyclical movemen in he shor run. 18

21 The rend-cycle decomposiion resuls display some ineresing facs. Comparing response behavior generaed by he permanen (rend) and ransiory (cycle) componens we find ha he rend behavior of he ASEAN-4 real exchange raes exhibis a high degree of comovemens boh in he long and shor erm. The correlaion coefficiens of he rend and cyclical componens are also posiively correlaed. We do no find any asynchronous behavior in heir long and shor run movemens; we find a high degree of comovemen among all counries wih respec o iming, duraion and inensiy of effec. This suggess ha he responses o he shocks and he speed of adjusmen were symmeric. Taking boh common rend and common cycles ino accoun his sudy suggess ha he ASEAN counries may expedie heir ongoing effors for moneary inegraion in he region. Of course, facors beyond exchange raes and economics mus also be examined. We do no preend o provide a comprehensive evaluaion of his possibiliy, bu raher presen evidence from differen angles ha may conribue o increase our undersanding of he economic dynamic of he region. Hence, a cauionary move is recommended during he process of creaing such an alliance. References: Abu-Qarn, A.S. and Abu-Bader, S. (2008) On he Opimaliy of a GCC Moneary Union: Srucural VAR; Common rends, and Common Cycles Evidence, The World Economy, 31, Adom, A. D., Sharma, S.C. and Morshed, A.K. M. (2010) Economic Inegraion in Africa, Quarerly Review of Economics and Finance, 50, Ahn, C.; Kim, H., and Chang, D. (2006) Is Eas Asia fi for an opimum currency area? An assessmen of he economic feasibiliy of a higher degree of moneary cooperaion in Eas Asia, The Developing Economies, XLIV, Basne, H.C. and Sharma, S.C. (2013) Exchange rae movemens and policy coordinaion in Lain America, Journal of Economics and Finance, (DOI: /s ). Basne, H.C. and Sharma, S.C. (2013b) Economic Inegraion in Lain America, Journal of Economic Inegraion, 28, Bayoumi, T. and Eichengreen, B. and Mauro, P. (2000) On regional moneary arrangemens for ASEAN, Journal of he Japanese and Inernaional Economies, 14, Beine, M., Candelon, B. and Hecq, A. (2000) Assessing a Perfec European Opimum Currency Area: A Common Cycles Approach, Empirica, 27,

22 Binner, J., Chen, S.H., Lai, K.H., Mullineux, A. and Swofford, J.L. (2011) Do he ASEAN counries and Taiwan form a common currency area? Journal of Inernaional Money and Finance, 30, Bhandaria, R. and Upadhyaya, K. P. (2010). Panel daa evidence of he impac of exchange rae uncerainy on privae invesmen in Souh-eas Asia, Applied Economics 42, Blanchard, O.J. and Quah, D. (1989) The Dynamic Effecs of Aggregae Demand and Supply Disurbances, American Economic Review, 79, Chin, L., and Azali, M. (2010) Currency linkages among ASEAN, The Singapore Economic Review, 55, Corinhas, C. (2009) Exchange rae pass-hrough in ASEAN: implicaions for he prospecs of moneary inegraion in he region, The Singapore Economic Review, 54, Darra, A. and Al-Shamsi, F. (2005) On he pah of inegraion in he Gulf region, Applied Economics, 37, Dickey, D.A. and Fuller, W.A. (1979) Disribuion of he esimaors for auogressive ime series wih a uni roo, Journal of American Saisical Associaion, 74, Dickey, D.A. and Fuller, W.A. (1981) Likelihood raio saisics for auoregressive ime series wih a uni roo, Economerica, 49, Enders, W. (1995) Applied Economerics Time series, New York, John Wiley and Sons, New York. Enders, W. and Hum, S. (1994) Theory and ess of generalized purchasing-power pariy: common rends and real exchange raes in he Pacific Rim, Review of Inernaional Economics, 2, Engle, R.F. and Issler, J.V. (1993) Common rends and common cycles in Lain America, Revisa Brasileira de Economia, 47, Engle, R.F. and Issler, J.V. (1995) Esimaing common secoral cycles, Journal of Moneary Economics, 35, Grimes, A. (2005) Regional and indusry cycles in Ausralasia: Implicaions for a common currency, Journal of Asian Economics, 16, Johansen, S. (1988) Saisical analysis of coinegraing vecors, Journal of Economic Dynamics and Conrol,12, Johansen, S. (1991) Esimaions and Hypohesis Tesing of Coinegraion Vecors in Gaussian Vecor Auoregressive Models, Economerica, 59, Kawai, M. (2008) Toward a Regional Exchange Rae Regime in Eas Asia, Pacific Economic Review, 13, Kim, D. (2007) An Eas Asian currency union? The empirical naure of macroeconomic shocks in Eas Asia, Journal of Asian Economics, 18, Kwiakowski, D., Phillips, P., Schmid, P. and Shin, Y. (1992) Tesing he null hypohesis of saionariy agains he alernaive of a uni roo, Journal of Economerics, 54, Mundell, R.A. (1961). A Theory of Opimum Currency Areas. American Economic Review, 51, Perron, P. (1988) Trends and random walks in macroeconomic ime series: Furher evidence from a new Approach, Journal of Economic Dynamics and Conrol, 12, Phillips, P. and Perron, P. (1988) Tesing for a uni roo in ime series regression, Biomerika, 75,

23 Ponines, V. and Siregar, R. (2009) Inervenion index and exchange rae regimes: he cases of seleced Eas-Asian economies, MPRA paper No Rao, C.R. (1973) Linear saisical inference. Wiley, New York, NY. Reinhar, C.M and Rogoff, K. S. (2002) The Modern Hisory of Exchange Rae Arrangemens: A reinerpreaion, NBER Working Paper Series, Working Paper Rhee, H.-J. (2012) Tesing for he possibiliy of a moneary union in he ASEAN+3 counries: raionaliy and asymmeric loss funcions, Applied Economic Leers, 19, Sao, K. and. Zhang, Z.Y. (2006) Real Oupu Co-movemens in Eas Asia: Any Evidence for a Moneary Union? The World Economy, 29, Sao, K, D. Allen, and Zhang, Z.Y. (2007) A Moneary Union in Eas Asia: Wha Does he Common Cycles Approach Tell?, in Lex Oxley and Don Kulasiri (eds.) MODSIM 2007 Inernaional Congress on Modelling and Simulaion. Modelling and Simulaion Sociey of Ausralia and New Zealand, December 2007, Sharma, S.C. and Wongbangpo, P. (2002) Long-erm rends and cycles in ASEAN sock markes, Review of Financial Economics, 11, Srobel, F. (2007) Souheas Asian moneary inegraion: a real opions perspecive, Applied Economics, 39, Sun, W. and Simons, G. (2011) Moneary Inegraion in Eas Asia: Evidence from Real Effecive Exchange Raes, Review of Inernaional Economics, 19, Tawadros, G. B. (2008) The endogeneiy of he opimum currency area crieria: an applicaion o ASEAN, Inernaional Economic Journal, 22, Vahid, F. and Engle, R. F. (1993) Common rends and common cycles, Journal of Applied Economerics, 8, Wilson, P. and Choy, K. M. (2007) Prospecs for enhanced exchange rae cooperaion in Eas Asia: some preliminary findings from generalized PPP heory, Applied Economics, 39, Table 1 Uni roo es Saisics. IND MYS PHL SGP THA * ~ z ( *) z( ) ~ z ( * ) z ( ~) KPSS 2.26* 1.81* 2.07* 1.78* 1.66* * indicaes he rejecion of he null hypohesis a 5% significance level. 21

24 The null hypohesis for he ADF ess [ ess [ z( *), z( ) ~, z( * ) and * z( ~) and ~ ] he DF ess ( 1 and 2 ) and he Phillips-Perron ] is ha he series is non-saionary. For he KPSS es, he null hypohesis is ha he series is saionary. The lag-lengh for he ADF ess is chosen by minimizing he AIC crieria. The DF ess assume ha each series is an AR(1) process. The lag-lengh for he Phillips Perron ess is deermined by using he Schwer (1986) formula. In{4( T /100) 0.25 } Table 2 Tes Saisics for he number of co-inegraing vecors. Eigenvalue Lags H 0 H A r 0 r 0 r 1 r 2 r 1 r 2 r 3 r 3 r 4 r 4 r 0 r 0 r 1 r 2 r 1 r 2 r 3 r 3 race Model A 62.05* Model B 62.81* *indicaes rejecion of he null hypohesis a 5% significance level. H 0 r 0 r 1 r 2 r 3 r 4 r 0 r 1 r 2 r 3 H A r 1 r 2 r 3 r 4 r 5 r 1 r 2 r 3 r 4 max 31.15* * 20.53* Table 3 Likelihood Raio Saisics o es for individual Coefficiens. Counry p-value 2 (1) IDN MYS PHL SGP THA Table 4 F-Saisics o es for he number of common cycles in Model B. Null DFs F-sa p-value 2 i s> s> s> ** 0.00 s> ** 0.00 **indicaes rejecion of he null hypohesis a 1% significance level. Table 5 22

25 Correlaions among rend and cyclical componens of real exchange raes MAL PHL SGP THA MAL PHL SGP THA Sandard Deviaion MAL PHL SGP THA Trends Cycles MAL=Malaysia, PHL=Philippines, SGP=Singapore, and THA=Thailand ( in able 1: IND = Indonesia) Lower riangular: coefficiens of rend componens. Upper riangular: coefficiens of cyclical componens. Fig 1: Trend componens of he ASEAN-4 real exchange raes PHL MYS THA SGP MYS PHL SGP THA 23

26 Fig 2: Cyclical componens of he ASEAN-4 real exchange raes THA -0.8 PHL SNG MYS Cycle_MYS Cycle PHL Cycle SNG Cycle THA 24