The effect of external shocks on macroeconomic fluctuations: Implications for a monetary union in East Asia

Recovering from the severe economic downturn during the currency crisis, East Asian countries have shown considerable economic growth again and regional integration appears to be accelerating. Such a deepening integration process recalls to us an interesting question as to whether a regional monetary union or a common currency unit can be established in East Asia. While the ongoing economic integration suggests the feasibility of regional monetary arrangements, a rigorous empirical investigation of this issue will be very necessary. In this paper we employ a structural VAR model with block exogeneity to comparatively investigate if external shocks originated from the US play a dominant role in influencing the macroeconomic fluctuations in East Asia during the sample period from 1978 to 2007. Our results indicate that the real output variable and inflation rate are highly correlated and statistically significant among the Asian NIEs and during both the whole sample period and the period after the financial crisis. The US real output growth was correlated significantly with that in Japan, Taiwan, Malaysia and Thailand during the period 1978-1987, but maintained significant correlation only with that of Hong Kong, Singapore and Taiwan during the post-crisis period. The real GDP growth in Japan has a significant correlation with the Asian NIEs and China during the post-crisis period, while the latter has only one significant correlation. This finding is consistent with the results from the correlation analysis of structural shocks using the conventional Blanchard and Quah (1989) technique. The results from the structural VAR model with block exogeneity show that the US shock and the Japanese shock are the dominant sources of disturbance in the region before the financial crisis, especially during the 1978-1987 period, both in terms of short run and long run, During the post-crisis period, it is found that the US shock has become the dominant source of the disturbance in most economies with the exception of the Chinese economy, while the Japanese influence has become decreased. The Chinese shock influence shows an increasing trend over time, but the size is still small and not compatible with that of the US shock. The world oil price shock has become increasingly important in influencing the stability of the real output growth in the region, most notably in the economies of China, Hong Kong, Singapore and Thailand. This indicates their increasing reliance on the world oil supply associated with their industrialization. The results also indicate that most of the East Asian economies have positive impulse responses to the external shocks originated from the United States through the different time periods, with the only exception of Indonesia during the post-crisis period. The impulse responses to the regional shock originated from China and Japan show an increasing trend, especially during the post crisis period, but the sizes are smaller and not compatible with that of the United States in all the time horizons. These findings imply that even though the regional integration appears to be deepening and accelerating especially after the recent financial crisis, the influence of the US shock is still playing a dominant role in real output fluctuations in the East Asian region. It is often pointed out that Japanese firms have been building a production network in East Asia through trade and investment, and also that China has grown rapidly and become a candidate of a regional key country. However, our result implies that the US influence in the region is still asymmetric and strong, and it is hard to conclude that shocks to the East Asian economies have become more regionally originated.