| After the political unification of Hong Kong with China, Hong Kongis supposed to function as a separate economic entity under theframework of "one country, two systems". However, the increasinglyclose ties between the two economies, particularly in recent years, haveraised the possibility of full economic integration despite politicalconstraints, and even of monetary union as the Chinese currencyprogresses towards full convertibility. This paper employs the theory ofoptimum currency area (OCA) and adopts the Kalman-filteringestimation technique to test whether Mainland China and Hong Kongconstitute an OCA. Especially, I concentrate on some cost aspects ofconstituting an OCA, namely on the degree of shock asymmetry betweenthe Mainland China and Hong Kong , with the objective of identifyingthe effects of economic integration on synchronization of shocks. The thesis comprises four chapters: Chapter one——"the issue raised". What is the significance of this paper? This chapter answers thisquestion. In the last two decades, Mainland China and Hong Kongexperienced a tremendous increase in economic interactions. For instance,Hong Kong is a main entrepot and intermediates the lion's share ofMainland China's external trade via re-exports and offshore trade. Also, asubstantial amount of international capital (in the form of foreign directinvestment, equity and bond financing and syndicated loans) financingMainland China's economic expansion is raised via Hong Kong. At thesame time, intermediating trade and financial flows to Mainland Chinahas become a major form of the economic activity in Hong Kong andgreatly shaped its economic structure. The extensive interaction betweenMainland China and Hong Kong provides a good foundation foradvancing integration to a higher level, namely constituting an OCA. Chapter two——"theoretic basis". This chapter plays an important role in the whole thesis, which isthe theoretic basis to make further analysis in the next chapter. Firstly, the theory of optimum currency area (OCA) is reviewedsystematically in this chapter. It is organized into three phases: the"pioneering phase" which put forward the OCA theory and its properties,the "reconciliation phase" when its diverse facets were combined, and the"reassessment phase" that led to the "new OCA theory". The main idea ofthis theory is that the economies gathering in a monetary union will faceadjustment costs due to differences in their economic structures. Themore similar economic structures are, the less these costs will be. Secondly, this chapter surveys the "endogeneity of OCA". There is alarge debate in economics on the link between economic integration andbusiness cycle co-movement. Two opposite views exist on this subject,classified by De Grauwe (1997) as "the endogeneity hypothesis" ofFrankel and Rose (1998) and "the specialization hypothesis" of Krugman(1993). According to the endogeneity hypothesis, closer integration leadsto less frequent asymmetric shocks and to more synchronized businesscycles between countries. On the other hand, for Krugman (1993) closerintegration implies higher specialization and, thus, higher risks ofidiosyncratic shocks. The overall impact of trade integration on shocksymmetry could thus be ambiguous, at least theoretically. Because of this,I have to resort to empirical approach. Chapter three——"model and empirical methodology". This chapter consists of two parts. In the first part, the paper develops a modified model based onlong-term utility maximization. Bringing to the dynamic trade-shockrelationship is the characteristic of this model. According to the model,the suitability of an OCA depends on bi-criteria, namely the "existingeconomic basis" and "dynamic trade-shock relationship". The second part introduces the empirical approach , which containsthree steps. First, I apply a bi-variate vector autoregressive procedureproposed by Blanchard and Quah (1989) to identify supply and demandshocks for Mainland China and Hong Kong. Then, using the Kalmanfilter... |
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