Monetary Covergence in East Asian Countries Relative to China: Evidence from Uncovered

The objective of this study applies stationary test with a flexible Fourier function proposed by Enders and Lee (2004, 2009) to test the validity of long-run real interest rate parity (RIRP) to assess the non-stationary properties of the real interest rate convergence relative to China for ten East Asian countries. We use monthly data from 1994:01 to 2011:06 and all data is taken from the CEIC DATASET. We find that our approximation has higher power to detect U-shaped breaks and smooth breaks than linear method if the true data generating process of interest rate convergence is in fact a stationary non-liner process. We examine the validity of RIRP from the non-linear point of view and provide robust evidence clearly indicate that RIRP holds true for ten East Asian countries. It implies that the choices and effectiveness of the monetary and fiscal policies in the East Asian economies will be highly influenced external factors originating from China. Also, our findings point out their real interest rate convergence relative to China is mean reversion towards RIRP equilibrium values in a non-linear way. It implies that transaction costs may be affecting the portfolio decisions of the international investors. Particularly, we provide further insight into the extent of capital mobility and financial integration in this region. Given the evidence of Strong RIRP, the choices and effectiveness of the monetary and fiscal policies in the East Asian economies will be very much influenced by external factors originating from China. Judging from the finding that East Asian countries are high integrated with China; China has yet to further liberalize its financial system as leading financial center or as anchor country for common currency area in this region.