When Central Banks Should Advocate Euro Adoption

Abstract

This study applies a GARCH-in-Mean model to the money market rates of seven members of the European Union (EU) which have not yet adopted the common currency – Sweden, Denmark, the UK, the Czech Republic, Hungary, Poland, and Romania. The aim is to evaluate whether there is a need for local monetary policy judged by the existence of persistent and de-synchronized shocks to the money market. However, the pre-requisite for local monetary policy is sufficient influence a central bank needs to have over the local money market. We tend to find answers by ARCH/GARCH modeling of daily money market rates. The applied model is a GARCH (1, 1)-in-Mean model with the euroarea money market rate – the Euribor – and the exchange rates as regressors. The results reveal persistent shock transmission in most cases, but very strong in case of Hungary. Further, results demonstrate low influence over the money markets against the Euribor of the central banks of Sweden, Denmark, and Hungary. The central banks of these countries will loose least impact on their money market, and have a case advocating euroadoption. Poland turned out to be the only country with a mean-reverting money market and a high influence of the central bank.