The Effect of External Shocks on Macroeconomic Fluctuations: Implications for a Monetary Union in East Asia

Transcription

1 18 h World IMCS / MODSIM Congress, Cairns, usralia July 2009 The Effec of Exernal Shocks on Macroeconomic Flucuaions: Implicaions for a Moneary Union in Eas sia Sao, K. 1, Z.Y. Zhang 2 and M. Mcleer 3 1 Faculy of Economics, Yokohama Naional Universiy, Japan 2 School of ccouning, Finance and Economics, Edih Cowan Universiy, usralia 3 Deparmen of pplied Economics, Naional Chung Hsing Universiy, and Economeric Insiue, Erasmus Universiy Roerdam sao@ynu.ac.jp (Sao), zhaoyong.zhang@ecu.edu.au (Zhang) and michael.mcaleer@gmail.com (Mcleer) bsrac: Recovering from he severe economic downurn during he currency crisis, Eas sian counries have shown considerable economic growh again and regional inegraion appears o be acceleraing. Such a deepening inegraion process recalls o us an ineresing quesion as o wheher a regional moneary union or a common currency uni can be esablished in Eas sia. While he ongoing economic inegraion suggess he feasibiliy of regional moneary arrangemens, a rigorous empirical invesigaion of his issue will be very necessary. In his paper we employ a srucural VR model wih block exogeneiy o comparaively invesigae if exernal shocks originaed from he US play a dominan role in influencing he macroeconomic flucuaions in Eas sia during he sample period from 1978 o Our resuls indicae ha he real oupu variable and inflaion rae are highly correlaed and saisically significan among he sian NIEs and during boh he whole sample period and he period afer he financial crisis. The US real oupu growh was correlaed significanly wih ha in Japan, Taiwan, Malaysia and Thailand during he period , bu mainained significan correlaion only wih ha of Hong Kong, Singapore and Taiwan during he pos-crisis period. The real GDP growh in Japan has a significan correlaion wih he sian NIEs and China during he pos-crisis period, while he laer has only one significan correlaion. This finding is consisen wih he resuls from he correlaion analysis of srucural shocks using he convenional Blanchard and Quah (1989) echnique. The resuls from he srucural VR model wih block exogeneiy show ha he US shock and he Japanese shock are he dominan sources of disurbance in he region before he financial crisis, especially during he period, boh in erms of shor run and long run, During he pos-crisis period, i is found ha he US shock has become he dominan source of he disurbance in mos economies wih he excepion of he Chinese economy, while he Japanese influence has become decreased. The Chinese shock influence shows an increasing rend over ime, bu he size is sill small and no compaible wih ha of he US shock. The world oil price shock has become increasingly imporan in influencing he sabiliy of he real oupu growh in he region, mos noably in he economies of China, Hong Kong, Singapore and Thailand. This indicaes heir increasing reliance on he world oil supply associaed wih heir indusrializaion. The resuls also indicae ha mos of he Eas sian economies have posiive impulse responses o he exernal shocks originaed from he Unied Saes hrough he differen ime periods, wih he only excepion of Indonesia during he poscrisis period. The impulse responses o he regional shock originaed from China and Japan show an increasing rend, especially during he pos crisis period, bu he sizes are smaller and no compaible wih ha of he Unied Saes in all he ime horizons. These findings imply ha even hough he regional inegraion appears o be deepening and acceleraing especially afer he recen financial crisis, he influence of he US shock is sill playing a dominan role in real oupu flucuaions in he Eas sian region. I is ofen poined ou ha Japanese firms have been building a producion nework in Eas sia hrough rade and invesmen, and also ha China has grown rapidly and become a candidae of a regional key counry. However, our resul implies ha he US influence in he region is sill asymmeric and srong, and i is hard o conclude ha shocks o he Eas sian economies have become more regionally originaed. Keywords: Srucural vecor auoregression; Moneary union; Exernal shocks; Eas sia JEL classificaion: F33; F36; F

2 Sao, Zhang & Mcleer, Effec of Exernal Shocks on Macroeconomic Flucuaions 1. INTRODUCTION Recovering from severe economic downurn during he currency crisis, Eas sian counries 1 have shown considerable economic growh again and regional inegraion appears o be acceleraing. Such a deepening inegraion process recalls o us an ineresing quesion as o wheher a regional moneary union or a common currency uni can be esablished in Eas sia. While he ongoing economic inegraion suggess he feasibiliy of regional moneary arrangemens, a rigorous empirical invesigaion of his issue will be very necessary. There have been so far a number of sudies examining he feasibiliy of forming a moneary union in Eas sia (for insance, Bayoumi and Eichengreen, 1994, Bayoumi e al., 2000 and Chow and Kim, 2003). These sudies ypically explore wheher he counries in quesion mee some of he precondiions se in he heory of opimum currency area. Recen sudies, such as Cheung and Yuen (2005) and Sao and Zhang (2006), invesigae he correlaions in srucural shocks and real oupu comovemens among he Eas sian counries and find ha some sub-groups of he counries are poenial candidaes for esablishing a moneary union. However, hese sudies do no ake ino consideraion wheher he degree of correlaions in srucural shocks or real oupu co-movemens have improved over ime. Noably Zhang and Sao (2008) examine he ime-varying correlaion in srucural shocks o assess he viabiliy of forming a moneary union in Greaer China area from a dynamic perspecive. The advanage of his dynamic approach is ha i will allow us no only o assess he dynamic process of shock correlaion and convergence rend, bu also o deermine he shock correlaion which is no caused by he ouside economies. This is especially imporan when we assess he feasibiliy of forming a moneary union in he Eas sian region given is unique dynamic inegraion process and business linkages wih he Unied Saes. Indeed, our lae findings also confirm he dynamic process and increasing correlaions of boh real oupu growh raes and srucural shocks in he pos-crisis period among some Eas sian counries. I herefore remains an ineresing quesion o ask wheher or no he co-movemens of macroeconomic variables in he region have been driven by he exernal shocks such as he US shocks. The economic influence of he Unied Saes in he Eas sian region is beer refleced in he saying, when merica sneezed, Japan and Europe used o cach a cold. To deermine he conen of he US influence has imporan implicaions for esablishing a regional moneary arrangemen. Recenly, here has been a growing lieraure analysing he effec of exernal shocks on he economic growh and he macroeconomic flucuaions in he emerging economies. IMF (2007), for insance, ackles a broad quesion of how far he emerging economies can decouple from he US economy, and invesigaes wheher he US shocks affec business cycle flucuaions in some major currency areas including Eas sia, Lain merica, and Sub-Saharan frica using various empirical mehods such as a panel analysis, a srucural VR esimaion and a dynamic facor model. Canova (2005), Genberg (2005) and Makowiak (2007) have done similar sudies by adoping he VR echnique o examine he effec of he US moneary shocks or China s impac on he emerging economies in Eas sian and Lain merica. However, mos of hese sudies cover he period during he 1980s and he 1990s and could no fully cach he effec of he recen economic crises experienced by hese emerging economies. This paper aims a assessing wheher he co-movemens of macroeconomic variables in he region have been affeced by he exernal shocks or driven by auonomous developmen of regional economies. In paricular, we invesigae which shocks have a dominan effec, shocks originaed from he wo regional key counries, i.e., Japan or China, or he ones from he Unied Saes. We firs conduc a correlaion analysis of he real oupu growh and domesic inflaion among hese economies o invesigae he dynamic srucural changes over ime. We also assess he shock disurbances obained by he Blanchard and Quah (1989) srucural decomposiion mehod o deermine he rend of he shocks correlaion. Then, we se up a srucural VR model wih block exogeneiy so ha we can examine o wha exen he US shocks has an influence on macroeconomic flucuaions in he Eas sian economies, and if he exernal shocks dominae he shock disurbance or he inernal shocks. Finally, he variance decomposiion es and he impulse response funcion analysis are conduced o invesigae he size of shocks and he speed of adjusmen o shocks for he economies concerned. The resuls indicae ha he US shocks are an imporan source of real oupu flucuaions in five Eas sian counries, while he Japanese and Chinese shocks are comparaively less imporan. In addiion, he impulse responses of real oupus o US shocks are posiive and much larger in he five Eas sian 1 In his paper, Eas sia is defined as he following 9 economies: Korea, Taiwan, Hong Kong, Singapore, Malaysia, Indonesia, Thailand, he Philippines, and Mainland China

3 Sao, Zhang & Mcleer, Effec of Exernal Shocks on Macroeconomic Flucuaions counries during he pos-crisis period han he corresponding impulse responses o he Japanese and Chinese shocks, even hough he Japanese firms have been building a producion nework in Eas sia in he pas few decades and China has emerged o be a rading naion and he world s manufacuring cenre since he lae 1990s. This has imporan implicaions for he feasibiliy of regional moneary arrangemens in Eas sia. The remainder of his paper is organized as follows. In secion 2, we discuss he analyical framework and mehodology employed in he paper. Secion 3 describes he daa issue, and secion 4 presens he resuls of empirical esimaion. Secion 5 provides some concluding remarks. 2. NLYTICL FRMEWORK To allow for he effec of exernal shocks on regional economies, le us consider he following near- VR model wih block exogeneiy: 2 p s= y y 1, s 2, s ε1, = ε 2,, where 12 = 0 for each s = 0, 1,, p, y 1, is a vecor of variables exernal o he domesic counry, and y 2, is a vecor of macroeconomic variables in he domesic counry. vecor of ε = ε 1, ε 2,, is uncorrelaed wih pas s ε y s, s > 0 = E ε y s, s > 0 =. 1, srucural shocks, [ ] E [ ε ] I and [ ] 0 y for s > 0 and saisfies ε is a vecor of srucural shocks of exernal origin and ε 2, ha of domesic origin. The model is formulaed separaely for each Eas sian economy ha is assumed o be a small open economy. We impose he block exogeneiy resricion, 0 for each s = 0, 1 p, which indicaes ha domesic shocks, ε, have neiher 12 = conemporaneous nor lagged effecs on exernal variables, y, foreign block, 1, includes hree variables: he world oil price changes, and he real oupu growh in he Unied Saes and Japan. We also include China s real oupu growh insead of he Japanese one o analyze he effec of he emerging Chinese economy on he res of he region. In he foreign block, i is assumed ha he US and Japanese (or Chinese) real oupu growh raes do no affec he world oil price changes eiher conemporaneously or wih lags. I is furher assumed ha shocks o he US real oupu growh (he US shock) affecs conemporaneously he real oupu growh in Japan or China, bu y, no vice versa. counry-specific block, 2, includes wo variables: he real oupu growh and he domesic inflaion. In he counry-specific block, we impose he long-run zero resricions like Blanchard and Quah (1989) where only a shock o he firs variable (real oupu growh), i.e., he domesic supply shock, affec he real oupu growh in he long-run; and boh he supply shock and he shock o he second variable (domesic inflaion), i.e., he domesic demand shock, affec he domesic inflaion in he long-run. Thus, we use he SUR esimaion wih he above block exogenous assumpion o idenify srucural shocks by imposing boh conemporaneous and long-run resricions. We use RTS 6.0 for esimaion, and choose one lag for his near-vr sysem due o he small sample size. 3. DT y 1,. We use he real GDP and consumer price index (CPI) series as proxies for he real oupu and he domesic price, respecively. The world oil price index in erms of he US dollar is also included in a near-vr model o allow for he effec of he world oil price shock on domesic real oupu and prices. ll daa are quarerly, expressed in naural logarihms. Seasonaliy is adjused using he Census X12 mehod. The sample period covers 1978Q1-2007Q4 excep for he Hong Kong CPI (1980Q4-2007Q4) 2, 2 See Cushaman and Zha (1997), Zha (1999), and Makowiak (2007) for an analysis using he near-vr model wih block exogeneiy

4 Sao, Zhang & Mcleer, Effec of Exernal Shocks on Macroeconomic Flucuaions and he Chinese CPI (1986Q1-2007Q4). The major daa sources are IMF, Inernaional Financial Saisics (IFS), CD-ROM ediion and he CEIC Global Daabase as well as China Monhly Saisics. The whole sample period is furher divided ino hree sub-samples, i.e., 1978Q1-1987Q4, 1988Q1-1996Q4, and 1999Q1-2007Q4, o beer capure he dynamic evoluion process of he shocks correlaion over he sample period. Moreover, daa for is excluded from he sample o eliminae he possible impac of he sian currency crisis. Due o he small sample size, we do no perform coinegraion analysis. We employ a firs-difference VR model o ensure saionariy of variables, 4. EMPIRICL RESULTS We have conduced a correlaion analysis of he variables among he concerned economies and also calculaed he correlaion coefficiens of he idenified srucural shocks following he Blanchard and Quah (1989) srucural decomposiion mehod. Due o he space limiaion, he resuls are no repored, bu available upon reques from he auhors. The resuls from correlaion analysis indicae ha he real oupu variable and inflaion rae are highly correlaed and significan a he 5% significan level mosly among he sian NIEs and during boh he whole sample period and he period afer he financial crisis. In paricular, he correlaion coefficiens of he real oupu growh among he economies of Hong Kong, Korea, Singapore and Taiwan range from 0.20 o 0.51 during he period and from 0.34 o 0.71 during he pos-crisis period in Before he financial crisis, Japan s real oupu growh is found o be correlaed only wih ha of Korea. During he pos-crisis period, i has been found o be correlaed wih ha of he four Eas sian Tigers plus China and Malaysia, wih he coefficien ranging from 0.24 he lowes wih Korea o 0.36 he highes wih China. The change of he correlaion paern for he Chinese economy is no as noable as one migh expec, increased from a null significan correlaion before he crisis o only one significan correlaion wih Japan while keeping a coefficien of 0.27 wih Hong Kong and 0.16 wih Singapore. The US real oupu growh was correlaed significanly wih ha in Japan, Taiwan, Malaysia and Thailand during he period , bu mainained significan correlaion only wih ha of Hong Kong, Singapore and Taiwan. The evoluion paern of he correlaion coefficiens for he real oupu growh in he region is a reflecion of he deepening regional inegraion hrough rade and invesmen and policy coordinaion during he pos-crisis period. Our resuls from he shocks correlaion a la Blanchard and Quah (1989) also confirm ha he degree of correlaion in supply shocks has improved subsanially during he pos-crisis period. Table 1. Variance Decomposiion of Real GDP Growh Rae due o US and Japanese Shocks Horizon KR TW HK SG MY ID TH PH CH. 1978Q1-1987Q4 (Quarers) Oil shock US shock Jp shock B. 1988Q1-1996Q4 Oil shock US shock Jp shock C. 1999Q1-2007Q4 Oil shock US shock Jp shock Noe: 1-12 denoes he average beween 1 quarer afer a shock and 12 quarers afer a shock denoes he average beween 13 quarers afer a shock and 24 quarers afer a shock

5 Sao, Zhang & Mcleer, Effec of Exernal Shocks on Macroeconomic Flucuaions The evoluion of he inflaion raes correlaion shows a slighly differen paern from he real oupu growh. ll he concerned economies excep China and he Philippines are significanly correlaed in heir domesic inflaion raes during he period , and become less so since he lae 1980s. In conras, China and he Philippines have become increasingly correlaed in inflaion raes wih he res of he Eas sian economies and he Unied Saes since he lae 1980s. In paricular, he number of significan correlaion of he inflaion raes for China has gone up o six, wih only one negaive correlaion coefficien wih Indonesia, during he pos-crisis period. This finding reflecs he increasing influence of he emerging Chinese economy in he region. Table 2. Resuls of Impulse Responses of Domesic Oupu o Exernal Shocks of One Sandard Deviaion: US and Japanese Shocks Horizon KR TW HK SG MY ID TH PH CH. 1980Q1-1988Q4 Oil shock US shock Jp shock B. 1989Q1-1996Q4 Oil shock US shock Jp shock C. 1999Q1-2006Q4 Oil shock US shock Jp shock Noe: The impulse responses are percenage deviaions. 1-4 denoes he average beween 1 quarer afer a shock and 4 quarers afer a shock denoes he average beween 1 quarer afer a shock and 12 quarers afer a shock denoes he average beween 13 quarers afer a shock and 24 quarers afer a shock. We now urn o he variance decomposiion and he impulse response analysis o idenify he dominan shock influence and he speed of adjusmen. Since he esimaed srucural shocks are assumed o have uni variances in he srucural VR mehod, heir size and adjusmen speed can be inferred by analyzing he associaed impulse response funcions (Bayoumi and Eichengreen, 1994). In his sudy, we use differen horizons o invesigae he effec of a uni shock on changes in real GDP and CPI as a measure of he size of differen shocks, The speed of adjusmen is measured by he response afer a horizon average beween one and four-quarer and also beween one and welve-quarer. The larger is he size of he shocks, he more disrupive will be he effecs on an economy. Tables 1 and 2 presens he resuls of variance decomposiion in real oupu growh and he impulse response of real oupu o he oil price shock, US and Japanese shocks. Due o he space limiaion, we repor only he resuls of

6 Sao, Zhang & Mcleer, Effec of Exernal Shocks on Macroeconomic Flucuaions variance decomposiion in real oupu growh wih he US shocks and Japanese shocks. The resuls for inflaion raes and for he Chinese shock are available upon reques. We find ha he US shock and he Japanese shock are he dominan sources of disurbance in he region before he financial crisis, especially during he period, boh in erms of shor run and long run, The influence of he US shock is mos visible in he economies of Taiwan, Thailand, he Philippines, while he Japanese shock is mosly noed in Hong Kong, Indonesia, Korea, and Singapore. This finding seems o be consisen wih he wo counries business and invesmen locaions in he region. I is noed ha afer he financial crisis, he US shock has become he dominan source of he disurbance in mos economies wih he excepion of he Chinese economy, while he Japanese influence has become decreased. lhough no repored, he Chinese shock influence shows an increasing rend over ime, bu he size is sill small and no compaible wih ha of he US shock. From Table 1, we also noe ha he world oil price shock has become increasingly imporan in influencing he sabiliy of he real oupu growh in he region, mos noably in he economies of China, Hong Kong, Singapore and Thailand. This indicaes heir increasing reliance on he world oil supply associaed wih heir indusrializaion. I is also ineresing o noe ha Indonesia and Thailand are less affeced by exernal shocks, bu he Philippines are more affeced by he Chinese shock. The resuls of he variance decomposiion for inflaion show ha he world oil price shock is an imporan source of price flucuaions in mos economies, followed by he US shock. The Chinese influence in domesic price level is persisen and mosly noed in Hong Kong, which is a clear reflecion of he high degree of economic inegraion beween he wo economies. s he real oupu co-movemens and business cycle synchronizaion are viewed as one of he mos crucial precondiion for forming an opimum currency area, we now urn o he effec of exernal shocks on real oupu growh of he Eas sian economies. I can be seen from Table 2 ha mos of he Eas sian economies have posiive impulse responses o he exernal shocks originaed from he Unied Saes hrough he differen ime periods, wih he only excepion of Indonesia pos he financial crisis. The impulse responses o he regional shock originaed from China and Japan show an increasing rend, especially during he pos crisis period, bu he sizes are smaller and no compaible wih ha of he Unied Saes in all he ime horizons. These findings imply ha even hough he regional inegraion appears o be deepening and acceleraing especially afer he recen financial crisis, he influence of he US shock is sill playing a dominan role in real oupu flucuaions in he Eas sian region. 5. CONCLUDING REMRKS In his paper we employed a srucural VR model wih block exogeneiy o comparaively invesigae if exernal shocks originaed from he US play a dominan role in he macroeconomic flucuaions in Eas sia during he sample period from 1978 o We find ha he real oupu variable and inflaion rae are highly correlaed and saisically significan among he sian NIEs and during boh he whole sample period and he period afer he financial crisis. The US real oupu growh was correlaed significanly wih ha in Japan, Taiwan, Malaysia and Thailand during he period , bu mainained significan correlaion only wih ha of Hong Kong, Singapore and Taiwan during he pos-crisis period. The real GDP growh in Japan has a significan correlaion wih he sian NIEs and China during he pos-crisis period, while he laer has only one significan correlaion. This finding is consisen wih he resuls from he correlaion analysis of srucural shocks using he convenional Blanchard and Quah (1989) echnique. The resuls from he srucural VR model wih block exogeneiy show ha he US shock and he Japanese shock are he dominan sources of disurbance in he region before he financial crisis, especially during he period, boh in erms of shor run and long run, During he pos-crisis period, i is found ha he US shock has become he dominan source of he disurbance in mos economies wih he excepion of he Chinese economy, while he Japanese influence has become decreased. The Chinese shock influence shows an increasing rend over ime, bu he size is sill small and no compaible wih ha of he US shock. The world oil price shock has become increasingly imporan in influencing he sabiliy of he real oupu growh in he region, mos noably in he economies of China, Hong Kong, Singapore and Thailand. This indicaes heir increasing reliance on he world oil supply associaed wih heir indusrializaion. The resuls also indicae ha mos of he Eas sian economies have posiive impulse responses o he exernal shocks originaed from he Unied Saes hrough he differen ime periods, wih he only excepion of Indonesia during he pos

7 Sao, Zhang & Mcleer, Effec of Exernal Shocks on Macroeconomic Flucuaions crisis period. The impulse responses o he regional shock originaed from China and Japan show an increasing rend, especially during he pos crisis period, bu he sizes are smaller and no compaible wih ha of he Unied Saes in all he ime horizons. These findings imply ha even hough he regional inegraion appears o be deepening and acceleraing especially afer he recen financial crisis, he influence of he US shock is sill playing a dominan role in real oupu flucuaions in he Eas sian region. I is ofen poined ou ha Japanese firms have been building a producion nework in Eas sia hrough rade and invesmen, and also ha China has grown rapidly and become a candidae of a regional key counry. However, our resul implies ha he US influence in he region is sill asymmeric and srong, and i is hard o conclude ha shocks o he Eas sian economies have become more regionally originaed. CKNOWLEDGEMENTS This sudy is financially suppored by he Japan Sociey for he Promoion of Science hrough he Gran-in-id for Scienific Research (S), REFERENCES Bayoumi, T. and B. Eichengreen, 1994, One Money or Many? nalyzing he Prospecs for Moneary Unificaion in Various Pars of he World, Princeon Sudies in Inernaional Finance, No.16. Bayoumi, T., B. Eichengreen and P. Mauro, 2000, On Regional Moneary rrangemens for SEN, Journal of he Japanese and Iner-naional Economies, 14, pp Blanchard, O.J. and D. Quah, 1989, The Dynamic Effecs of ggregae Demand and Supply Disurbances, merican Economic Review, 79, pp Canova, Fabio, 2005, The Transmission of US Shocks o Lain merica, Journal of pplied Economerics, 20, pp Cheung, Y.-W. and J. Yuen, 2005, The Suiabiliy of a Greaer China Currency Union, Pacific Economic Review, 10(1), pp Chow, H.K. and Y. Kim, 2003, Common Currency Peg in Eas sia? Perspecives from Wesern Europe, Journal of Macroeconomics, 25, pp Cushman, David O. and Tao Zha, 1997, Idenifying Moneary Policy in a Small Open Economy Under Flexible Exchange Raes, Journal of Moneary Economics, 39, pp Genberg, Hans, 2005, Exernal Shocks, Transmission Mechanisms and Deflaion in sia, BIS Working Papers, No.187, Bank for Inernaional Selemens. Inernaional Moneary Fund (IMF), 2007, Decoupling he Train? Spillovers and Cycles in he Global Economy, World Economic Oulook, pril, pp Japan Exernal Trade Organizaion (JETRO), 2007, 2007 JETRO Whie Paper on Inernaional Trade and Foreign Direc Invesmen, Japan Exernal Trade Organizaion. Makowiak, Barosz, 2007, Exernal Shocks, U.S. Moneary Policy and Macroeconomic Flucuaions in Emerging Markes, Journal of Moneary Economics, 54, pp Rodriguez, R.N., 1982, Correlaion, in S. Koz and N.L. Johnson (eds.), Encyclopedia of Saisical Sciences, Vol.2, Wiley, pp Sao, Kiyoaka and Zhaoyong Zhang, 2006, Real Oupu Co-movemens in Eas sia: ny Evidence for a Moneary Union? The World Economy, 29(12), pp Zha, Tao, 1999, Bloc Recursion and Srucural Vecor uoregression, Journal of Economerics, 90, pp Zhang, Zhaoyong and Kiyoaka Sao, 2008, Whiher Currency Union in Greaer China? Open Economies Review, 19(3), pp