Hong Kong’s business cycle synchronisation with Mainland China and the US

inSight

21 Sep 2006

Hong Kong’s business cycle synchronisation with Mainland China and the US

 

Research by the HKMA shows that, despite increasing integration between the Hong Kong and Mainland economies, co-movements of business cycles between the two are mainly explained by developments in the US affecting both.

Readers may wish to study an article published in the HKMA Quarterly Bulletin today about Hong Kong's economic integration and business cycle synchronisation with Mainland China and the United States and its implications for our exchange rate policy. A summary is as follows.

 

Impressions

(1) The economy of Hong Kong is increasingly integrated with that of the Mainland through trade in goods and services, foreign direct investment and financial flows.
(2) Hong Kong is more economically dependent upon the Mainland now than it was upon the United States in 1983 when the Linked Exchange Rate system was established.

 

Question

Is it now more appropriate, if a stable exchange rate remains the monetary policy objective of Hong Kong, for the exchange rate anchor to be the renminbi rather than the US dollar?

 

Theory

(1) The degree of business cycle synchronisation between two economies has important implications for the optimal monetary arrangement between them. An intra-area fixed exchange rate or a common currency is the most appropriate for economies that are closely integrated through common product and factor markets, have similar degrees of business cycle synchronisation, and are subject to common economic shocks.
(2) However, if shocks are predominantly economy-specific or idiosyncratic, then the ability to conduct independent monetary and fiscal policies becomes more important in helping an economy adjust to such shocks.

 

HKMA Research Findings

(1) Co-movements of business cycles in Hong Kong and the Mainland have increased steadily since the 1990s.
(2) There has also been a significant increase in the synchronisation of business cycles among the economies of the Mainland, Hong Kong and the United States since 2000.
(3) In the short run, Hong Kong's output and price changes are mostly affected by its own shocks.
(4) Over the medium to long run, about 60% and 45% respectively of variations in output and prices in Hong Kong can be explained by US shocks, while the impact of Mainland shocks concentrates mostly on Hong Kong price movements, explaining about one third of them.
(5) There is little correlation between the business cycles in Hong Kong and the Mainland in the absence of the common US influences, whereas the influence of the US shocks on these two economies leads to a high degree of synchronisation.
(6) The lack of similarity of domestic shocks between Hong Kong and the Mainland can be mostly attributed to their continuing differences in economic structure and being at different stages of economic development.

 

Conclusions

(1) The US dollar continues to be the appropriate anchor for the Hong Kong dollar for the foreseeable future.
(2) In any case, with the renminbi not being a freely convertible currency and not a reserve currency, it is technically not possible for it to be a currency anchor.
(3) No change, therefore, is needed to the Linked Exchange Rate system.

 

Joseph Yam
21 September 2006

 

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Last revision date : 21 September 2006