A Currency Union Or An Exchange Rate Union Evidence From.docVIP

Revised version 12/12/2006 A Currency Union or an Exchange Rate Union: Evidence from Northeast Asia( Bang Nam Jeon* Drexel University and Hongfang Zhang Drexel University Abstract This paper examines whether or not Northeast Asia economies, namely, China, Japan, Korea, and Taiwan, can form a currency union, where a single currency and a uniform monetary policy are adopted, or an exchange rate union where all the currencies are pegged to an internal or external currency or an optimum currency basket. The analysis of correlations of supply shocks, exchange rate shocks, monetary shocks, and demand shocks, which are estimated applying the structural VAR model with identification restrictions imposed, to the data for the period from 1970 through 2004, shows that shocks of these economies are not symmetric, in general, implying that the Northeast Asian economies are not ready yet to form a common currency union. However, it is found that the Northeast Asian countries can form an exchange rate union with a major currency basket, which consists of the U.S. dollar, the euro and the Japanese yen, as an anchor currency. The paper also examines the option of pegging to a basket of regional currencies, similar to the Asian Currency Unit (ACU), and discusses policy implications. JEL Classification: F33, F36 Key words: currency union, exchange rate union, optimum currency areas, Northeast Asia * Bang Nam Jeon, Ph.D. [corresponding author] Professor of Economics and International Business Bennett S. LeBow College of Business Drexel University 32nd and Market Streets Philadelphia, PA 19104 Tel: (215) 895-2125, Fax: (215) 895-6975 e-mail: jeonbana@ Hongfang Zhang Department of Economics and Business Bennett S. LeBow College of Business Drexel University I. Introduction This paper examines whether the Northeast Asian economies, namely, China, Japan, Korea, and Taiwan, can form a currency union where a s