International Journal of Business and Accountancy, Vol. 1, No.

1, 47-62, 2010

Feasibility of a Single Currency for the

ASEAN-5
Song Kuok Thong1
INTI International University, Malaysia

A.S. Santhapparaj

Multimedia University, Malaysia

Sayed Hossain3
Multimedia University, Malaysia

Abstract
According to Mundell (1961), an optimum currency area is an economic unit
composed of regions affected symmetrically by disturbances and between which
labour and other factors of production flow freely. The issues of forming a single
currency in the ASEAN countries have long been debated by the government of the
member of ASEAN. Ironically, these countries would also choose not to surrender
their own countys currency which made the idea of forming an OCA nearly
impossible. It is also worth to note that the formation of an OCA within the ASEAN
members may not be as simple as the European Union due to the mix results obtained
by previous studies. This paper will examines the feasibility of forming an Optimum
Currency Area (OCA) among the ASEAN-5, which are Indonesia, Malaysia,
Philippines, Singapore and Thailand, by testing the symmetry of underlying structural
shocks. This paper will further suggest the feasible sub regions to form the OCA
within these ASEAN-5.The results imply that it would be difficult for the ASEAN-5
to form a currency union, however there is a possibility for Malaysia, Singapore and
Thailand to spearhead the formation of the single currency.

Keywords: Optimum Currency Area; ASEAN-5; Currency Union; Single Currency;

Structural Shocks; SVAR

Acknowledgement: The authors wish to thank the two independent reviewers for
their valuable comments and suggestions.
1

The author is a Senior Lecturer in Economics, Faculty of Business and Accountancy, INTI
International University. He could be contacted at kuokthong.song@newinti.edu.my.
2
The author is a Professor in Economics with the Faculty of Management, Multimedia University. He
could be contacted at santhapparaj@mmu.edu.my
3
The author is a Lecturer in Econometrics with the Faculty of Management, Multimedia University. He
could be contacted at sh@mmu.edu.my.

Song Kuok Thong, A.S. Santhapparaj and Sayed Hossain

1.0 Introduction
A single currency refers to the ability of establishing one single central bank which
would replace all other existing central banks in the region. This single central bank
would than further adopt a common exchange rate and monetary policies for the
region to adopt.
Mundell (1961) was one of the first economists to argue against the system of
national currencies connected by flexible exchange rates. He came up with a system
where currencies are not defined by national borders, but by geographic areas in
which the factor mobility among the countries is high.
With such argument by Mundell, nations began to consider the feasibleness for
nations to merge with one another, which was to some extent, was considered to be
farfetched. However the European Union was the first ever group of nations willing
to take risks of making Mundells theory comes true. The formation of the single
currency in Europe in the year 1999 somehow has inspired other countries around the
world to form an economic integration including the ASEAN countries. However the
success of such economic integration would also depend on the optimum of the
currency. There have been many arguments among scholars as well as nation leaders
today on the readiness for ASEAN to form such single currency between the member
countries. ASEAN was established in the year 1967 by five member countries mainly
Malaysia, Singapore, Indonesia, Thailand and the Philippines. The members of
ASEAN eventually extended to Brunei, Laos, Vietnam, Myanmar and Combodia
between the year 1984 and 1999. This paper will only be focusing on the original
ASEAN five members, specifically Malaysia, Singapore, Indonesia, Thailand and the
Philippines. These five ASEAN countries are selected as they have a record of
continuous high level of GDP and volume of trade among the rest of the ASEAN
members (ASEAN Secretariat, 2005).

2.0 Literature Review

Neo Classical Optimum Currency Theories
According to Mundell (1961), an Optimum Currency Area (OCA) would take place
between countries where labour mobility is relatively high within a particular group
but low between nonmembers as well as between different groups of OCA. Mundell
further argues that when a high demand shock hits a member of an OCA, this will
cause the labour to move from one country to another member country within the
OCA. As such employment rate among the group remains at its original level. Hence
the wage rate among the members of the OCA will continue to remain equal. As such,
the role of the exchange rates between members will have little impact in restoring
internal stability among the OCA. Mundell (1961) also suggests that the economy
of the OCA should remain in full employment. He concludes that a country with full
employment would lead to an excess money supply. As such, this would cause
spending to increase, which eventually results in a trade deficit. The trade deficit
would than cause the exchange rate to fall, which eventually will push the central
bank to use foreign currencies to buy the national currency. As this continues, the
high-powered money in the system would eventually fall, which in turn causes the
money supply to fall through the money multiplier effect. Finally import will fall
which will then eliminate the trade deficit.

48

Feasibility of a Single Currency for the ASEAN-5

According to Corden (1972), such factor mobility introduced by Mundell (1961)

can be differentiated between the physical factors of production other than labour, and
labour mobility. The physical factors of production would lead to the worsening of
business conditions in a country due to the limited investment whereas labour
mobility would be able to ease the adjustment to permanent shocks. However, Corden
(1972) also argues that exchange rates also play an important role for an economic
integration to take place.
Mc Kinnon (1964) and Kenen (1969) further developed Mundells theory by
focusing on the characteristics which would make the single currency more or less
desirable. They conclude that countries are highly integrated within a geographical
area when factor mobility, financial transactions, and commodity trading are high.
Such findings are similar to Mundell (1961) in which he argues that the internal factor
mobility would assist in the establishment of an OCA. McKinnon (1964) and
Kenen (1969) also point out that a small, open and diversified production structured
country would have a better chance of integrating and forming of an OCA.
The New Optimum Currency Area Theories
A more recent study on the OCA was conducted by Plumper and Troeger (2004). By
employing the Mundellian model to test the relationship between currency union and
economic efficiency in Europe, they concluded that the currency union would have an
adverse effect on countries that are non members of the Union in terms of reduction
in the autonomy monetary policy.
Alesina and Barro (2002) on the other hand conclude that countries with lack of
internal discipline for monetary policy would gain from giving up their currencies as
the anchored country would be able to provide and commit to the sound monetary
policy for them. The model also concludes that smaller countries would benefit more
when giving up their currency.
De Grauwe (2000) highlights that fixed exchange rate regime would increased
the volatility in output. He argues that countries trying to reduce such uncertainty
would only shift the risk to another area of the economy. As such although monetary
integration would reduce risk, such risk would only shift to a new lower risk
equilibrium.
According to Frankel and Rose (1997), the OCA theory and the prerequisites for
the formation of monetary union introduced by Mundell (1961) and other neo
classical theorists are just actually reinforced by the creation of monetary union. They
further argue that the increase in the economic integration would increase the
convergence between nations which eventually reduces the loss of exchange rate
control by the monetary union.
However, Krugman (1993) believes that the increased in the economic
integration would eventually lead to the increased in the asymmetric shocks. He
argues that such economic integration would cause countries to specilise in specific
localized outputs, which eventually lead to divergence, thus increasing the costs of
monetary union.
Currency Union in ASEAN Countries
The issue for ASEAN feasibility to form a single currency union has been long
debated. Leaders of the ASEAN countries have shown great resistance in giving up
their own currency, yet they continue to discuss on the formation of an OCA within
the ASEAN itself. Even though, Mundell had suggested that such single currency

49

Song Kuok Thong, A.S. Santhapparaj and Sayed Hossain

would benefit the members of the OCA, ASEAN should still examine the feasibility
of the formation of a currency union for ASEAN itself in order to convince the
leaders of ASEAN that such OCA would bring a positive impact to their countries.
However the case of ASEAN may not be as simple as in the case of the
European Union. Many studies have been conducted with regard to the OCA within
the East Asia countries, which gave a mix of results.
Xu Mingqi (2003) for example, studied on the possibility and feasibility of East
Asian monetary integration. He concludes that the feasibility of the East Asia may
work if only the East Asia countries are able to ensure that the Asian Monetary Fund
become a reality. Xu Mingqi (2003) also concludes that the Chiang Mai Initiative and
the foundation for further monetary cooperation in exchange management could
eventually assist in the process of monetary integration and eventually towards a
single optimum currency.
Sung Yeung Kwack (2003) concludes that forming a single currency region in
East Asia could be possible. However, he concludes that the OCA within the East
Asia would not materialise as long as leaders of the East Asia fail to commit in such
cooperation in East Asia. He suggests that the formation of a quasi-monetary bloc
would be the next best option towards political convergence as well as economic
convergence. With these convergences on the way, the establishment of a common
monetary standard will be easier to reach.
However, Wyplosz (2001) argues that East Asia still has a long way to become a
currency union. By examining and comparing the East Asia with Europe, he
concludes that there are three main differences between the two nations: (i) the
sequencing; whereby Europe started with a trade cooperation whereas the Asia
countries are still in the midst of developing a framework for common trade
agreements. (ii) Asian countries seem to be concerned with the exchange rate stability
vis--vis the world at large instead of stability of the exchange rate within the region
itself. (iii) the reluctance among the Asian leaders to have a common institution
building in Asia.
Wyplosz (2001) conclusion was highly supported by Castellano (2000), whereby
he concludes that the monetary union in East Asia is unachievable. He however does
conclude that Asia would still have a fighting chance in creating an OCA if leaders
are able to resolve the territorial disputes and cultural animosities.
Williamson (1999) however has a different opinion on the formation of a
currency union in East Asia. By conducting a research based on nine East Asian
Currencies (China, Hong Kong, Indonesia, Korea, Malaysia, the Philippines,
Singapore, Taiwan and Thailand), he concludes that these countries should adopt a
common currency, surrounded by fluctuation bands of plus-and-minus ten percent.
Bayoumi and Eichengreen (1999) also analysed the economic and political
prospects for monetary integration in East Asia. They conclude that the region meets
the optimum currency area criteria to adopt a single currency. They conclude that
Asian countries would benefit from such common peg as their economy is small and
open. They also discover that the Intra trade and investment between the Asian
countries is high enough which causes adjustments to demand and supply shocks to
be fast, small and symmetric.
The Single Currency Model
Zhang, Sato and McAleer (2003) studied the possibility of a single currency within
the East Asia by employing a three-variable Structural Vector Autoregrression (SVAR)

50

Feasibility of a Single Currency for the ASEAN-5

model. The purpose of the SVAR model is to identify the underlying shocks across
the East Asian economies. By identifying the shocks they are able to assess the
suitability of the East Asian economies to obtain a monetary integration. The shocks
employed by Zhang, Sato and McAleer (2003) include supply shocks, demand shocks
and monetary shocks, which ran a span of two decades of quarterly data from East
Asia. They are able to conclude that the exchange rates of East Asian economies are
relatively stable. However, they find that the economy of the East Asia displays a less
coherent pattern in GDP growth than that of inflation. Overall, the empirical results
do not suggest for the East Asian region to form an OCA. However, they conclude
that sub-regions such as ASEAN countries would show a potential OCA as their
disturbances are correlated and small and are able to adjust to shocks rapidly.
Trivisvavet (2001) also employed the Structural Vector Autoregrression (SVAR)
model to examine the feasibility of the formation of currency union among eight of
the East Asian countries, mainly Thailand, Malaysia, Singapore, The Philippines,
Japan, Korea, Indonesia and Hong Kong. He concludes that the East Asian countries
have a high chance of forming a monetary union. However he suggests that with an
exception of Indonesia, East Asia may need to consider forming a monetary union
among sub regions such as the Southeast Asian countries.

3.0 Measurement Procedures

For the purpose of this study, a two variable Structural VAR model will be employed
to examine the shock aspect of the optimum currency area (OCA) by focusing on the
government of five leading ASEAN countries, which comprise Malaysia, Thailand,
Singapore, Indonesia and the Philippines. The model is based on Clarida and Gali
(1994), whereby they have employed a three-variable Structural VAR model to study
the sources of real exchange rate fluctuations. Such Structural VAR model has also
been employed by Funke (2000) and Hazel Yuen (2001) in determining the OCA in
Asia.
Although most authors have included the exchange rate shocks into their model,
we will only apply a two-variable Structural VAR model which consists of home
output and home price level, as most of the ASEAN-5 countries have adopted a fixed
exchange rate regime since the financial crisis in 1997. Our study covers the period
between 1969 and 2008 and is constructed by secondary data collected from
Quarterly Balance of Payment Report and Quarterly International Financial Statistic
Report.
By using the variables above, the structural model can be written as:
Yt = 1Yt-1 + 2Yt-2

+ +nYt-n + t

(1)

whereby; Yt is the 2 X 1 vector which comprises the log-difference form of xt (real

GDP), pt (CPI), is the 2 X 2 matrix of parameters, and t is the 2 X 1 vector of
residuals comprising of tx and tp.
For the model to work, we will assume that the structural shocks Yt Yst, Ydt,
is serially uncorrelated and has a covariance matrix normalized to the identity matrix,
whereby Yst, and Ydt, are the supply and demand shocks, respectively. As proposed
by Blanchard and Quah (1989), the GDP and inflation shocks need to be defined in
terms of supply and demand shocks. It is important to note that both GDP and
inflation shocks are combination of and dependent on the supply and demand shocks.

51

Song Kuok Thong, A.S. Santhapparaj and Sayed Hossain

As such it is crucial to decompose real GDP and inflation shocks into supply and
demand shocks or statistically
t = Aet

(2)

whereby A is the constant variables of a 2X2matrix, and et is a 2X1 vector which

comprises supply shocks (ets) and demand shocks (etd). To identify the structural
shocks, we will impose the following long run restrictions:
1. the output is affected by the supply shock
2. the exchange rates are affected by both the supply shock and demand shocks
3. Monetary shocks will not affect the output level and the price level in the
long run.
For the 3rd restriction, we can rewrite equation (1) as
Yt = C0et + C1et-1 + C2et-2 +

Yt Li Ci et

(3)

i 0

whereby Li is the lag operators and Ci is the matrices which can be obtained from by
inverting the VAR model. As such the equation (3) can be written in matrix form as

yt x11i
p Li x
t i 0 21i

x12i etd

x22i ets

(4)

whereby yt and pt are the real GDP and inflation shocks respectively.
Since demand shock will not cause any changes to the output in the long run, we can
therefore imply that

X
i 0

11i

(5)

or in terms of vector autoregression:

q11i

q
i 0

21i

q12i z11
q 22i z 21

z12 0 .

z 22 . .

(6)

Whereby the 2X2 matrix of Yi is equivalent to a 2X2 matrix of [1-Y(L)]-1 which are
extracted from equation 1 above. For the long run observation, equation 1 can be
rewritten as:
Yt = 1Yt + 2Yt + + nYt +t
(1 - 1 - 2 - 3 - - n) Yt = t
Yt = (1 - 1 - 2 - 3 - - n)-1 t

(7)

52

Feasibility of a Single Currency for the ASEAN-5

Since 1, 2, n is derived from equation 1 of the vector autoregression model, we

can therefore conclude that:
q11i * x11 + q12i*x21 = 0

(8)

Next we define as a 2X2 covariance matrix of ty and tp and e as a 2X2

covariance matrix of etd and ets. By recalling equation 2, we can thus conclude that:
e = AAT

(9)

whereby AT is a transpose matrix for A. From equation (9), we will obtain the
following equations after some matrix multiplications:
z112 + z122 = Var ty
z212 + z222 = Var tp
z11 * z21 + z12 * z22 = Cov (ty, tp)

(10)
(11)
(12)

From equation (8), (10), (11) and (12), we are able to determine the matrix A.
Equation (2) can also be rewritten in an inverse matrix form as:
A-1t = et

(13)

As such we are able to determine etd and ets from equation (13) above.
4.0 Currency Union for ASEAN-5 Model

Structural Shocks
Shocks are believed to be the driving forces of many macroeconomic systems. Such
structural shocks are usually unobservable and are linked to an economic model
which the implication to it would be either permanent or transitory.
A supply shock occurs when there is a sudden and unexpected increase in the
input price or decrease in the resource available. This in turn would cause the
aggregate supply to shift unexpectedly. On the other hand, a demand shock occurs
when there is a sudden increase or decrease in the aggregate demand. Such demand
shocks can be due to the changes in the money supply and government expenditure.
According to Mundell (1961), countries have a better chance to converge if the
response to both the demand and supply shocks is similar across the nations. Such
studies are also been supported by Zhang, Sato and McAleer (2003) whereby they
tested on the correlation of shocks and the response of shocks between nations.
Descriptive Statistics
Before analyzing these data, it will be useful for us to consider the unprocessed form.
With reference to Table I, the standard deviations indicate to us that the fluctuation
for demand shock and supply shock have been generally smaller across the ASEAN-5.
The mean for demand shock and supply shock also indicates a constant mean across
the ASEAN-5.

53

Song Kuok Thong, A.S. Santhapparaj and Sayed Hossain

Table I: Descriptive Statistics for ASEAN-5

Indonesia
Malaysia
Philippines
Singapore
Thailand

Demand
Supply
Demand
Supply
Demand
Supply
Demand
Supply
Demand
Supply

Mean

Median

3.749269
22.94273
1.127642
22.22183
2.355198
12.04256
0.459609
20.79146
1.633417
18.42395

4.095344
23.02184
1.911023
22.43741
2.985682
12.61106
0.741937
21.13203
2.317474
18.52610

Standard
Deviation
1.695936
4.092841
2.201918
2.486954
2.622655
3.352113
2.481941
2.546520
2.382662
2.762792

Observation
40
40
40
40
40
40
40
40
40
40

Correlations of Structural Shocks

We will first investigate the order of integration of each series by employing the
augmented Dickey-Fuller (ADF) and the Phillip-Perron (PP) unit root tests. Both
ADF and PP tests are used to identify whether the series are nonstationary and are
integrated of the same order, which is a prerequisite for conducting the cointegration
test and the analysis that follows.
As demonstrated by Johansen (1991), the procedure involves the identification
of rank of the m by m matrix as shown below:

Zt = + Zt-n + I Zt-n + t
Where Zt is the column vector of the m variables, and are the coefficient
matrices, is the difference operator, n is the lag length and is the constant
variable.
From Table II, the results suggest that the t-statistics for all the series in the ADF
test are statistically insignificant for all variables in level form but are stationary at
first difference. The results for the ADF test are confirmed by employing the
Phillip-Perron (PP) tests in Table III below.
The next step in our analysis is to test for the presence of cointegration among
the I(1) variables. In this study, we employ the popular Johansen and Juselius (JJ)
procedure (1990) of testing for multiple cointegrating vectors. Results of applying the
Johansen-Juselius procedure are presented in Table IV and Table V.
The series are tested using the cointegrating VAR of unrestricted intercepts with
no trend. Table IV indicates the results for the Demand Shocks. Both the maximum
Eigenvalue and Trace statistics indicate that there exists at most one unique
cointegrating vector for all the five ASEAN countries (Indonesia, Malaysia,
Singapore, Thailand and the Philippines). This means that the statistics could reject
the hypothesis of no cointegrating vectors for the entire sample period since the null
of r=0 can be rejected at 5% critical values. Given the presence of one cointegrating
vector among the I(1) variables, we can also conclude there exist (t n) = 4 common
stochastic trends in the system for the case of these countries. This means that the
model is driven by four common stochastic trends that can be associated with the
demand and supply shocks among the ASEAN-5. The analysis reveals that all the
demand shocks for the five ASEAN countries seem to be cointegrated and suggests

54

Feasibility of a Single Currency for the ASEAN-5

Table II: Augmented Dickey-Fuller (ADF) Unit Root Test for GDP and CPI for
ASEAN-5
Indonesia
Demand
Supply
Singapore
Demand
Supply
Thailand
Demand
Supply
Malaysia
Demand
Supply
The
Philippines
Demand
Supply

Level
No Trend
-0.548482[1]
1.71038[1]
Level
No Trend
-2.223314[1]
-1.744320[1]
Level
No Trend
-2.771247[1]
2.438068[1]
Level
No Trend
-1.765980[1]
0.249093[1]
Level
No Trend
-2.727379[1]
-1.270438[1]

Trend
-2.076283[1]
-0.159953[1]
Trend
-2.211074[1]
1.380015[1]
Trend
-2.901678[1]
-0.786702[1]
Trend
-2.128599[1]
-2.558560[1]

Trend
-2.402920[1]
1.443326[1]

First Difference
No trend
-8.046178[1]**
-3.283155[1]**
First Difference
No trend
-6.724737[1]**
-4.978058[1]**
First Difference
No trend
-7.930258[1]**
-2.933564[1]**
First Difference
No trend
-7.883875[1]**
-6.266182[1]**
First Difference
No trend
-8.602878[1]**
-4.418184[1]**

Trend
-8.608832[1]**
-4.271862[1]**
Trend
-6.611069[1]**
-5.229927[1]**
Trend
-7.761763[1]**
-3.535540[1]**
Trend
-7.748491[1]**
-6.210713[1]**

Trend
-8.471258[1]**
-5.702823[1]**

Note:** denotes significant at 5% significant level

Demand
: is the demand shock for country i
Supply
: is the supply shock for country i

Table III: Phillip-Perron (PP) Unit Root Test for GDP and CPI for ASEAN-5
Indonesia
Demand
Supply
Singapore
Demand
Supply
Thailand
Demand
Supply
Malaysia
Demand
Supply
The Philippines
Demand
Supply

Level
No Trend
-1.601889[1]
-1.2145[1]
Level
No Trend
-2.594434[1]
-3.0113[1]
Level
No Trend
-2.821762[1]
-1.2889[1]
Level
No Trend
-2.915797[1]
-0.6201[1]
Level
No Trend
-2.742237[1]
-1.95631[1]

Trend
-2.855419[1]
-2.9355[1]
Trend
-2.472039[1]
-0.6672[1]
Trend
-2.690409[1]
-0.9721[1]
Trend
-2.751564[1]
-1.7818[1]
Trend
-2.302778[1]
-0.0744[1]

First Difference
No trend
-6.737183[1]**
-7.3072[1]**
First Difference
No trend
-8.773336[1]**
-3.5297[1]**
First Difference
No trend
-9.355371[1]**
-26.3866[1]**
First Difference
No trend
-8.196709[1]**
-5.0084[1]**
First Difference
No trend
-9.232299[1]**
-4.7848[1]**

Trend
-6.594376[1]**
-7.6443[1]**
Trend
-9.206099[1]**
-3.9768[1]**
Trend
-9.610337[1]**
-35.8340[1]**
Trend
-8.431630[1]**
-4.9875[1]**
Trend
-19.22761[1]**
-5.44829[1]**

Note:
*, ** and *** denote significant at 10%, 5% and 1% significant levels respectively. Figures in brackets are optimum
lag length. Demand is the real CPI of the countryi; Supply is the real GDP of the countryi.

55

Song Kuok Thong, A.S. Santhapparaj and Sayed Hossain

that the series share a long-run equilibrium relationship and there is a common trend
driving movement of the variables in the system.
Table IV: Multivariate Cointegration Test for the Demand Shock of the
ASEAN-5
H0
r=0
r1
r2
r3
r4

Maximum
Eigenvalue
36.10433
16.61865
13.49994
8.778608
3.729766

95%
Critical Value
33.87687*
27.58434
21.13162
14.26460
3.841466

Trace Test
78.73130
42.62697
26.00832
12.50837
3.729766

95%
Critical value
69.81889*
47.85613
29.79707
15.49471
3.841466

Note:* denotes statistical significant at the 95% significant level

r is the number of cointegrating vector.

Table V, on the other hand, shows the cointegrating result for the Supply
Shocks. Both the maximum Eigenvalue and Trace statistics indicate that there exists
at most one unique cointegrating vector for the ASEAN-5. This suggests that the
countries are able to maintain a level of macroeconomic policies that is consistent
with the optimum currency area.
Table V: Multivariate Cointegration Test for the Supply Shock of the ASEAN-5
H0
r=0
r1
r2
r3
r4

Maximum
Eigenvalue
67.82406
26.41569
18.46053
10.17291
4.419201

95%
Critical Value
38.33101*
32.11832
25.82321
19.38704
12.51798

Trace Test
127.2924
59.46834
33.05265
14.59211
4.419201

95%
Critical value
88.80380*
63.87610
42.91525
25.87211
12.51798

Note:* denotes statistical significant at the 95% significant level

r is the number of cointegrating vector.

The underlying shocks, which are demand shock and supply shock, are
estimated by the structural VAR approach for the ASEAN-5 economies for whole
sample period (1969 2003). It is assumed that if the correlation of structural shock is
positive, the shocks are considered to be symmetric and if correlation of structural
shock is negative, then the shocks are asymmetric (Mundell, 1961).
Table VI shows the correlation of the demand shocks across ASEAN-5. Overall,
the correlation of the shock is considered to be symmetry, except for the case of
Indonesia Singapore. There is evidence that indicates a strong correlation between
the ASEAN countries at 95% significance level. From table VI, we can also conclude
that Singapore, Malaysia and Thailand exhibit a high correlation demand shocks.
Such high degree of correlation among these three countries could be due to the
similar monetary policies (Ng, 2002).
Table VII, on the other hand, shows the correlations of supply shock for the
ASEAN-5. It can be concluded from the table that all the ASEAN-5 have high
correlation except for Indonesia and other ASEAN countries. We can also observe
that the shocks are mostly asymmetry especially for Indonesia Malaysia, Indonesia
Thailand, Malaysia the Philippines, Malaysia Singapore, the Philippines
Thailand and Singapore Thailand. Such asymmetry shocks indicate that there is

56

Feasibility of a Single Currency for the ASEAN-5

high level of trade barriers among these countries that produces homogeneous goods
(European Commission, 1990). However it is worth to note that the supply shocks
between Malaysia, Singapore and Thailand are significantly correlated.
Table VI: Correlation of Demand Shocks for the ASEAN-5
DEIND
DEMAL
DEPHIL
DESING
DETHAI

DEIND
1

DEMAL

DEPHIL

DESING

DETHAI

0.445969
0.475769
-0.062004
0.357623

1
0.330136
0.518148
0.478465

1
0.302068
0.217994

1
0.525517

Note:
DEIND: demand shocks for Indonesia; DEMAL: demand shocks for Malaysia; DEPHIL: demand shocks for the
Philippines; DESING: demand shocks for Singapore; DETHAI: demand shocks for Thailand

Table VII: Correlation of Supply Shocks for the ASEAN-5

SUIND
SUMAL
SUPLHIL
SUSING
SUTHAI

SUIND
1
-0.120623
0.057139
0.068211
-0.023444

SUMAL

SUPLHIL

SUSING

SUTHAI

1
-0.424679
-0.788163
0.566510

1
0.725254
-0.431978

1
-0.692336

Note:
SUIND: demand shocks for Indonesia; SUMAL: demand shocks for Malaysia; SUPHIL: demand shocks for the
Philippines; SUSING: demand shocks for Singapore; SUTHAI: demand shocks for Thailand

According to Bayoumi and Eichengreen (1994), they suggest that the value of
0.5 could be used as a critical level of correlation for the formation of a currency
union. The value of 0.5 is determined by indentifying the correlation between growth
and inflation among the Group of Three (G-3) countries, which comprises United
State, Japan and Germany which are used as the basis of the choice of the underlying
correlation. Both the growth and inflation indicate an approximate correlation of 0.5.
As such the value of 0.5 is used as the null hypothesis. By employing the conclusion
by Bayoumi and Eichengreen, we can therefore conclude that the ASEAN-5 has a
high potential to form an optimum currency area (OCA) except for Indonesia. As
such, by examining the above results we can conclude that Singapore, Malaysia and
Thailand seem to be the most suitable candidates to form a currency union. An
accumulated impulse response test to the shocks will next be investigated to confirm
whether Malaysia, Singapore and Thailand do exhibit a high possibility to form an
OCA.

Figure I and Figure II show the results for the generalized impulse
response for demand and supply shocks respectively among the ASEAN-5.
From Figure I, we can conclude that all the long run relations of the demand
shocks (inflation shocks) of the ASEAN-5 converge to zero after the shocks
die away. However the time paths have different shapes for different shocks.
The life span of the demand shocks ranges from 8 to 10 quarters. The impulse
responses of demand shocks for the Philippines and Indonesia however reveal

57

Song Kuok Thong, A.S. Santhapparaj and Sayed Hossain

a pre-shock level after the 10 quarters. Malaysia, Singapore and Thailand

however indicate a faster adjustment to the same shocks as to the Philippines
and Indonesia. Figure II indicates the impulse response for the supply shocks
of the ASEAN-5. Only Indonesia and Thailand long run relations of the
supply shocks (real GDP shocks) converge to zero after the shocks die away.
However this is only true after the 10 quarters.
5.0 Conclusion
Although the European countries are able to form an Optimum Currency Area (OCA),
it is important for ASEAN to address the disparity that exists between the two
different economic regions before deciding on the formation of an OCA. The ASEAN
members should first of all understand that the European countries started with trade
cooperation whereas ASEAN is just on a free trade agreement. Even so, the
agreement within the ASEAN members has yet to develop a framework for common
trade agreements. Besides that, the ASEAN countries should also look into the
formation of a common central bank among the ASEAN countries. The reluctance of
ASEAN members to acknowledge and give up on their own institution would only
make it harder for the ASEAN countries to regulate a common currency among the
ASEAN countries.
In summary, this study examines the symmetry and asymmetry of the demand
and supply shocks among the ASEAN-5. Overall, the finding shows that there is
symmetry and nearly high correlation for demand shocks. However the supply shock
tends to show an asymmetry correlation among most of the countries. Such results
can be due to the high trade barriers imposed by these countries. Malaysia, Singapore
and Thailand seem to show a high degree of correlation among the shocks as
compared to Indonesia and Thailand which suggest that there will be a faster
adjustments to the same shocks among these three countries. According to Zhang,
Sato and McAleer (2003), the supply shocks are considered to be more evaluating as
compared to the demand shock in determining the OCA. This is because the demand
shocks using SVAR method tend to include the effects of macroeconomic policies, as
well as purely stochastic disturbances (Zhang, Sato, and McAleer, 2003). Besides that,
Bayoumi and Eichengreen (1996) conclude that that the correlation of supply shocks
is more informative, since supply shock should be less sensitive to choice of
exchange rate arrangement. Thus, this study does suggest that there is a lack of
potential for the ASEAN Five to form a currency union, as there is fairly low but
significant correlation for the supply shock among the countries. However, there is a
higher possibility for the ASEAN-3 to form an OCA, mainly Malaysia, Singapore and
Thailand.
The path towards a single currency may not be as easy for the ASEAN countries
as compared to the European Union. The main reason for the upsetting of the OCA
among the ASEAN region is the difference in degree of the GDP per capita among its
members. Singapore, Malaysia, Thailand and Brunei are known for their high GDP
per capita as compared to Indonesia and the Philippines. Besides that, although most
of the ASEAN-5 has adopted a similar monetary policy, the difference in the
exchange rate regime among the member countries is evidence. As such members of
ASEAN would first need to agree to a similar exchange rate regime before they are
able to form a common currency.

58

Feasibility of a Single Currency for the ASEAN-5

Figure I: Generalized Impulse Response for Demand Shock

Response of ICPI to Cholesky
One S.D. Innovations

Response of MCPI to Cholesky

One S.D. Innovations

1.6

1.6
1.2

1.2

0.8
0.8
0.4
0.4
0.0
0.0

-0.4

-0.4

-0.8
1

ICPI
MCPI
PCPI

10

SCPI
TCPI

ICPI
MCPI
PCPI

Response of PCPI to Cholesky

One S.D. Innovations

10

10

SCPI
TCPI

Response of SCPI to Cholesky

One S.D. Innovations

1.6

1.6

1.2

1.2

0.8

0.8

0.4

0.4

0.0

0.0

-0.4

-0.4

-0.8

-0.8
1

ICPI
MCPI
PCPI

10

SCPI
TCPI

5
ICPI
MCPI
PCPI

Response of TCPI to Cholesky

One S.D. Innovations

SCPI
TCPI

1.6

1.2

0.8

0.4

0.0

-0.4
1

5
ICPI
MCPI
PCPI

10

SCPI
TCPI

Note:
ICPI : demand shocks for Indonesia
MCPI : demand shocks for Malaysia
SCPI : demand shocks for Singapore
TCPI : demand shocks for Thailand
PCPI : demand shocks for the Philippines

59

Song Kuok Thong, A.S. Santhapparaj and Sayed Hossain

Figure II: Generalized Impulse Response for Supply Shock

Response of IGDP to Cholesky
One S.D. Innovations

Response of MGDP to Cholesky

One S.D. Innovations

.4

.2

.0

-.2

-.4

-1

-.6

-2

-.8
1

IGDP
MGDP
PGDP

10

SGDP
TGDP

IGDP
MGDP
PGDP

Response of PGDP to Cholesky

One S.D. Innovations

10

10

SGDP
TGDP

Response of SGDP to Cholesky

One S.D. Innovations

.4

.4

.2

.2

.0

.0

-.2

-.2

-.4

-.4

-.6

-.6

-.8

-.8
1

IGDP
MGDP
PGDP

10

SGDP
TGDP

5
IGDP
MGDP
PGDP

Response of TGDP to Cholesky

One S.D. Innovations

SGDP
TGDP

4
3
2
1
0
-1
-2
1

IGDP
MGDP
PGDP

10

SGDP
TGDP

Note:
IGDP : supply shocks for Indonesia
MGDP: supply shocks for Malaysia
SGDP : supply shocks for Singapore
TGDP: supply shocks for Thailand
PGDP : supply shocks for the Philippines

60

Feasibility of a Single Currency for the ASEAN-5

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