East Asian currency union under discussion

Speaking at the London School of Economics yesterday, Peter Kenen set out to analyse whether countries in East Asia form an optimal currency area. One method used to test compatibility, according to Kenen, is to look at how closely economic shocks affecting one region are correlated with shocks in other countries. The higher the correlation between shocks, the stronger the case for monetary union.

Drawing on work in 1994, Kenen argued that there was a larger percentage of positive correlations for reaction to demand shocks for the East Asian countries tested than for the EU. The correlation was significantly high in one-third of the East Asian pairs, compared to just under one quarter of the pairs in the EU. The results of more recent papers had reinforced this, he said. However, China was poorly correlated with most of the other countries. Its economy is predicted to grow by many, including the OECD who predict it will soon be the world's largest exporter, so substantial changes in its exchange rate vis-a-vis other Asian currencies may therefore be needed, Kenen argued. Japan's economic size meant it too should not be included in the group.

It may be better, Professor Kenen said, to contemplate a smaller union comprising the principal ASEAN countries (Indonesia, Malaysia, Philippines, Singapore, and Thailand) plus Korea, but one that would be open to the other ASEAN members plus Taiwan if politically feasible.

Kenen admitted he did not know if the desire or political will was there to form such a currency union or whether middle-sized countries are likely to coalesce under the leadership of a bigger country. He acknowledged that institutions would need to be established to drive this, but said Asia did not have to follow exactly the same route as Europe. "Nevertheless," Kenen concluded, "I believe some subset of East Asian countries will form a monetary union within the next decade or soon thereafter."