The good, the Bad and the Ugly




A monetary union in laments terms is when
two or more nation states share the same
currency.
It has many variations
Examples are the EURO, and the US Dollar
It is a form of economic integration


Economic Integration is the unification of
economic policies with the primary purpose
of increasing efficiency and productivity.
This can involve
◦
◦
◦
◦
Elimination of Trade Barriers
Establishment of Free Trade Area’s
Adoption of a common currency
Harmonization of policy
Stages of Economic integration
activities inside the trade bloc
eliminating barriers for exchange of
Shared policies
Trade pact type
goods
goods
(non- services capital labour monetary fiscal
(tariffs)
tariff)
Preferential
trade agreement
TIFA BIT, TIFA
Free trade
agreement
Economic
partnership
Common market
Monetary union
Fiscal union
common barriers in external relations
goods
Tariff
Non- services capital labour
tariff
Customs union
Customs and
monetary union
Economic union
Economic and
monetary union
Complete
economic
integration
Yellow = [partial] — Green [substantial] — White [none or not applicable]




“Asymmetric” Unilateral adoption of currency
“dollarization”
Soft or hard peg
“Symmetrical” Bilateral or Multilateral
adoption of Currency
“Symmetrical” Bilateral or Multilateral
adoption of Currency with Integrated
Monetary policy
 WILLEM H. BUITER - The EMU and the NAMU



Member nations gave up their own currencies
and adopted the “Euro”
It is controlled by the European Central Bank
which is independent of all member nations
The ECB controls Monetary Policy for all
members of the EMU




Geographic Proximity
Implied microeconomic cost savings
Macroeconomic stabilization
Increased penetration of trade liberalization




It is only natural to partner up with your
neighbour
Majority of trade for East Asian Nations is
with other East Asian nations
Which implies that economic integration can
make a monetary union attractive for these
countries
External benefits



Transaction cost savings
higher efficiency
Elimination of Exchange Rate Risk




Evidence suggests that currency unions give
probable cause to the reduction of
asymmetries between economic zones
Further economic integration implies
convergence of business cycles
Reduces uncertainties in the economy which
encourage trade and investment
“The whole is greater then the sum of the
parts”




Adopting a common currency Eliminates
exchange rates and associated costs
This results in a reduction of cost for
producers
The elimination of foreign exchange markets
also eliminates exchange rate risk
This removes costs associated with exchange
rate uncertainty

Asymmetric Monetary Union
◦ Elimination of seigniorage revenues
◦ Elimination of exchange rate costs
◦ Conversion costs

Symmetric Monetary Union
◦ Gain or loss of seigniorage revenues
◦ Elimination of exchange rate costs
◦ Conversion costs




The issue of Sovereignty is the primary
concern
Nations lose policy sovereignty over their
monetary policy
Nations may or may not gain a stake in the
larger areas Monetary Sovereignty
This can lead to major issues for nation



The Eurozone has had its up’s and downs when it
comes to their monetary Union
Recent developments: Sovereign debt crisis
◦ What is it?
◦ ECB response
Is the Eurozone going to survive in light of the
sovereign debt crisis?
http://www.britannica.com/EBchecked/topic/1795026/European-sovereign-debt-crisis
http://www.stratfor.com/weekly/germanys-role-europe-and-european-debt-crisis
The Economist (http://www.economist.com/node/15838029)
The Economist - http://www.economist.com/blogs/freeexchange/2011/10/euro-crisis



Robert A. Mundell suggests several
preconditions in his Nobel prize winning
paper from 1961.
These are now known as Optimum Currency
Area (OCA) conditions
In this study we will continue by analysing
China, Japan and Korea’s capacity to meet
these conditions.


Trade Openness
Symmetry of shocks
◦ Speed of adjustment



Labour mobility
Financial integration
History of inflation



Trade linkages between China Japan and
Korea are strong
Consequently, this implies potential increased
efficiency gains from using a common
currency
This is because of elimination of exchange
rate risks, and other transaction costs.



Research done by David Kim in paper “An East
Asian Currency Union? The empirical nature of
macroeconomic shocks in East Asia” shows that
economic asymmetries between China, Japan and
Korea cause divergence in response to demand
and supply shocks
In the case of China, Japan and Korea a currency
union in the presence of somewhat asymmetrical
responses to shocks is less attractive
A visual representation is shown in the following
slides...

Fig. 1.1. Price–output co-movements—China, Japan and Korea.

Fig. 2.3. Output response to demand shocks.

Fig. 2.2. Inflation response to supply shocks.

Fig. 2.1. Output response to supply shocks..

Japan has a highly restrictive policy towards
foreign labour (Labour Mobility and east Asian
integration – Siow Yue CHIA)
◦ As mentioned by Prof. Han in class Japanese society is
xenophobic



South Korea is known to import labour and have
high labour mobility
Inter-china labour mobility between rural and
urban areas has increased substantially
Seeing as how OCA criterion suggests high
labour mobility we may expect member countries
to relax policy to encourage higher mobility




Financial Integration in East Asian economies is
very limited, especially when compared to Europe.
In the paper East Asian Currency Union by JongWha Lee and Robert J. Barro
determine that the average asset holding-to-GDP
ratios for east Asian economies is 5.0% which is
very low. In comparison Europe has a ratio of 59%
For example: Japan’s average asset holdings-toGDP ratio is only 0.5% with East Asia, while it is
14.4% with the United States and 14.1% with
Europe




China, Japan and Korea do not meet OCA
criteria
They need to make adjustments to their
Economies before they can enter a Monetary
Union
In light of our analysis is it worth it for these
countries to adopt a common currency?
Is it a good idea for North America?