Economic Integration - Optimum Currency Area and ASEAN

Discusses what an optimum currency area is, the pros and cons of joining a common currency area, and whether ASEAN can form a common currency area.

According to Carbaugh (2009), optimum currency area is a region in which it would be more preferable economically to have a single official currency instead of multiple official currencies. For example, Malaysia can be considered an optimal currency area. Malaysia consists of 13 states: 11 states in the peninsula of Malaysia and two states on the northern part of Borneo states. It would be inconceivable that the current volume of commerce among its 13 states would occur efficiently in a monetary environment of 13 different currencies. (Malaysia Tourism 2010)

The gains of an optimum currency area would be more uniform prices, lower transaction costs with greater certainty for investors and enhanced competition. Having a common currency area eliminates the risks associated with exchange fluctuations as cost of currency are lessened, resulting in more uniform prices (e.g. predictability of exchange rates) and lower transaction costs. Also, with a common currency area, “the economies are insulated from monetary disturbances and speculation, and political pressures for trade protection are reduced” (Carbaugh 2009, p282), providing greater certainty for investors and enhancing competition. In addition, having an independent central bank running a single monetary policy should promote price stability.

However, having a common currency area can also involve costs, particularly if interest-rate changes affect different economies in different ways: the inability of a single country to use inflation to reduce public debt in real terms, absence of individual domestic monetary policy to counter macroeconomics (external) shocks, and possible speculative attacks during the transition from individual currencies to a single currency. The three reactions to economic shocks are mobility of labor, flexibility of prices and wages, and automatic mechanism for transferring financial resources to the affected country.

With international transactions becoming a larger share of total global transactions, there is the likelihood that the attractiveness of common currencies relative to a multitude of sovereign currencies will increase. If countries with diverse sub-regions can adopt a common currency, it is possible for a region with diverse countries such as ASEAN to do the same; especially if there is sufficient potential economic interest for ASEAN countries to set their aside political differences and forge strategically beneficial political alliances. (Madhur 2002)

However, such economic and political integration amongst ASEAN countries in the region would be challenging and is a gradual process, which may span over some time (possibility decades); the preparatory groundwork itself is essential and would involve a considerable amount of effort as ASEAN does not have a strong fundamental financial system in place yet.

To manage a currency union for a group of countries with diverse levels of development, Madhur (2002) mentions that it would be important to allow freer flow of capital and labor across borders. In order to allow greater mobility of both capital and labor across national borders, this would need concerted efforts by the ASEAN governments: with member countries having to evolve necessary policies and mechanisms.

References:• Carbaugh, R J, 2009, International economics, 12th edn, South-Western Cengage Learning, USA

• Madhur, S, 2002, Costs and Benefits of a Common Currency for ASEAN, Asian Development Bank, May 2002

• Malaysia Tourism, viewed 10 April 2010, <http://www.tourism.gov.my/en/about/default.asp>

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Posted on Jun 23, 2012