A simulation study of an ASEAN monetary union ☆ J. Engwerda a, ⁎, O. Boldea b , T. Michalak c, d , J. Plasmans b, e , Salmah f a Tilburg University, Dept. of Econometrics and O.R., P.O. Box: 90153, 5000 LE Tilburg, The Netherlands b Tilburg University, The Netherlands c University of Southampton, England, United Kingdom d Warsaw University, Poland e Antwerp University, Belgium f Gadjah Mada University, Yogyakarta, Indonesia abstract article info Article history: Accepted 25 May 2012 Keywords: ASEAN economic integration Monetary union Linear quadratic differential games Open-loop information structure This paper analyzes some pros and cons of a monetary union for the ASEAN 1 countries, excluding Myanmar. We estimate a stylized open-economy dynamic general equilibrium model for the ASEAN countries. Using the framework of linear quadratic differential games, we contrast the potential gains or losses for these coun- tries due to economic shocks, in case they maintain their status-quo, they coordinate their monetary and/or fiscal policies, or form a monetary union. Assuming for all players open-loop information, we conclude that there are substantial gains from cooperation of monetary authorities. We also find that whether a monetary union improves upon monetary cooperation depends on the type of shocks and the extent of fiscal policy co- operation. Results are based both on a theoretical study of the structure of the estimated model and a simu- lation study. © 2012 Elsevier B.V. All rights reserved. 1. Introduction This paper studies the pros and cons of further economic integra- tion of the ASEAN countries. One of the major goals of the ASEAN countries is to achieve deeper regional integration. Since the launch of the ASEAN Free Trade Area (AFTA) in 1992, 2 ASEAN has entered the first stage toward the process of reaching full economic integra- tion. Full economic integration can be reached by subsequently for- ming a customs union, a common market, and an economic union. AFTA has reached its initial implementation in 2003. Systematic efforts to remove tariff and non-tariff barriers are being implemented, and all member countries are committed to make ASEAN a free trade and tariff zone by 2015. The current debates/challenges center around two questions whether further adjustments are required beyond the national borders and how to move toward creating an ASEAN Economic Community. Different views about the progress and the future of economic integration in ASEAN can be found in, e.g., the REPSF 3 publications over the last decade, Soesastro (2005), Plummer (2006), Soesastro (2007), Hashmi and Lee (2008), Lim and Yi-Xun (2008), Heydon and Woolcock (2009), Park and Park (2009). Following the seminal works of Mundell (1961) and McKinnon (1963) on optimum currency areas (OCAs), there have been numerous studies that assess the theoretical and practical implications of forming a monetary union (MU). In particular, the question whether countries form an OCA depends on the incidence of asymmetric shocks and the asymmetric transmission of shocks. Participating in a MU comes at the cost of losing monetary authority and exchange-rate adjustments as policy instruments. Additionally, being a member of a MU implies the need to comply with fiscal and other policy restrictions, like e.g. the Stability and Growth Pact (SGP) requirements in the European Monetary Union (EMU). On the other hand, alternative stabilization mechanisms may replace the role of the exchange-rate adjustment and there may be sizeable benefits outweighing the costs of participation to the MU. The OCA theory suggests that countries will establish a MU as soon as properly quantified economic benefits start to outweigh costs, see e.g. De Grauwe (2000). In a theoretical setting the question whether coun- tries constitute an OCA can be assessed by comparing the effects of an asymmetric shock in a country, when it continues its independent monetary policy, with the effects of the same shock once it has entered Economic Modelling 29 (2012) 1870–1890 ☆ We would like to thank the editor and an anonymous referee for their useful comments. ⁎ Corresponding author. E-mail address: engwerda@uvt.nl (J. Engwerda). 1 Association of Southeast Asian Nations, its members are: Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam. 2 ASEAN has been founded in 1967 by Indonesia, Malaysia, Philippines, Singapore and Thailand, and now consists of ten countries mentioned above. The objective is to promote economic, cultural and political cooperation among the member countries. During a summit on the island of Bali in 2003, the “Bali Concord” was signed which foresees an economic union by 2020. 3 The Regional Economic Policy Support Facility (REPSF) is one of the components of the ASEAN–Australia Development Cooperation Program. 0264-9993/$ – see front matter © 2012 Elsevier B.V. All rights reserved. doi:10.1016/j.econmod.2012.05.032 Contents lists available at SciVerse ScienceDirect Economic Modelling journal homepage: www.elsevier.com/locate/ecmod