Regional monetary integration in the presence of two large countries: What modality makes sense for East Asia?

This paper analyzes the modalities of East Asian monetary integration by taking note of the relevance of two large economies, one outside the region (the United States) and one inside (Japan), for monetary policy making. Within the framework of a three-country model, it derives the social welfare of two regional economies and uses numerical calibration to show how it crucially depends on the specific modality of monetary integration. By using parameters obtained from the actual macroeconomic data for 1981-1996, we find that the smaller regional economy (Korea) always benefits from monetary integration, while the large regional economy (Japan) benefits from monetary integration only when it is asymmetric (such as a peg to a common basket or yenization), so that it can continue to enjoy some monetary autonomy. Symmetric integration, while not a viable option for East Asia in the short run, may become feasible in the long run if economic integration deepens sufficiently to produce convergence in economic structure and synchronization of business cycles.