Subject:
"The Difference in Development Stages and the Costs of Monetary Union:
A New Open Macroeconomics Model"

by Mr. Vu Tuan Khai
(PhD candidate, Yokohama National University & VDF-Tokyo)

Summary

In the first workshop of the year 2007, VDF-Tokyo welcomed Mr. Vu Tuan Khai, a PhD candidate of the Yokohama National University (YNU) and a member of VDF-Tokyo, to present his theoretical macroeconomic model on the issue of forming a monetary union (or common currency area--CCA).

According to the presenter, formation of a CCA in East Asia has been in debates in a number of research and financial institutions recently. It is motivated by several factors, such as the recognition of the weakness of the unilateral dollar-peg regime after the severe financial crisis in 1997-98, and rapid economic integration prevailing inside the region. It is also obvious that economies in the region are at very different development levels, and thus forming a CCA needs to be considered thoroughly. Two questions, including why the difference in development stages makes the forming of a CCA difficult, and how to define development stage involved in forming such a CCA, are main research tasks to deal with the issue. To pursue these questions, in his paper, Mr. Khai would like to give an explicit definition of the concept difference in development stages by looking at the differences in sectors between the countries, and then builds a model, which extends the framework of the New Open Economy Macroeconomics (NOEM) originated from the work by Obstfeld and Rogoff (1995), to elucidate the effects and transmission mechanisms of numerous kinds of symmetric shocks.

Before making analysis on the models and estimations, Mr. Khai presented the differences in development stages in a number of countries in East Asia with statistical data. It is shown that the development levels of the countries in the sample data, e.g. Japan, South Korea, Indonesia, and Vietnam, are substantially different in terms of GDP per capita, economic structure (agricultural and industrial shares in GDP), and labor market. From such data comparisons, Mr. Khai pointed out some key characteristics of differences between developed and developing countries in the region. He also emphasized that his model would take agriculture and industry as two representative sectors of an economy.

The presentation went further with explanations of theoretical framework. At first, Mr. Khai briefly mentioned about the key assumptions of the NOEM. His model was then modified from that model by extending from one sector to two sectors (agriculture and industry), and these sectors are different in technology level, elasticity of substitution between goods, and the degree of price rigidity. Labors are allowed to move between sectors. In addition, the two countries (one is developed, and the other is developing) in the model are also different in terms of relative size of sectors, technology level, the degree of labor excess in agricultural sector.

To see how two countries and their sectors would change when shocks happened, Mr. Khai introduced four kinds of shocks to the model, including technology shocks to both sectors, monetary shocks, and government spending shocks, when the countries were initially in their steady states. All the changes were then considered in short-run (or adjustment period) and long-run (new steady states). To illustrate the model, numbers were assigned to variables and coefficients.

[For more information about the model, please see the presentation attached to this summary*].

Prof. Kenichi Ohno (GRIPS & VDF) started the discussion section by providing some comments on the setting of the model. According to him, the differences between the countries in East Asia are presented not only by economic structure, but also by the driving forces in each country. In addition, the model should clarify how labors and capitals move within and between the countries. In response, Mr. Khai said that it might be difficult to consider different driving forces for the model at this stage of the paper, and he would consider this in a new version. He also explained that labors are allowed to move within a country, but capitals are allowed to move domestically and internationally.

Another question was whether model could explain the impacts of labor excess by the same labor market equilibrium. This is a concern because agriculture sector is significantly different from industry sector. In the former, if there are too many workers and land is too limited, then there will be no productivity growth. Conversely, the latter can extend productive activities by more factories in order to absorb more labors. Mr. Khai responded that it could explain the impacts if he assigned different values for coefficients related to the labor market. However, in the current presentation, different results derived from different coefficients were not shown.

Mr. Long (GRIPS & VDF-Tokyo) raised a question about definition of capital, because he thought that different types of capitals would bring different rates of return, and thus shocks might have different impacts on capital-related variables. In his explanation, Mr. Khai said that capital is considered only in bond, and thus it would help the model to be simpler, particularly in estimating household budget constraint.

A question was commonly shared between the participant was that technology shocks (innovation) in industry sector led to the reduction of labor. This finding might be not popular in practice because it depended on specific industries in consideration. Mr. Khai said that he would consider different values of technology coefficients in order to see how the situation would be changed.

At the end of the presentation, Mr. Khai thanked all the participants for comments and questions. He hoped that a new version of paper, which would take relevant variables and assumptions, would be accomplished in the coming time. We concluded the workshop by providing some information on forthcoming activities, including monthly workshop and preparation for VDF-Tokyo Third Conference.

 * Paper (PDF477KB) | Slides (PDF163KB)

 (By Giang Thanh Long)