Optimum Currency Research Articles

MONETARY UNION FEASIBILITY IN THE EAST AFRICAN COMMUNITY: EVIDENCE FROM GPPP

This study utilises the generalised purchasing power parity (GPPP) to assess the feasibility of a monetary union in the East African Community (EAC) region. Time series and panel vector error correction models (VCM) were used to analyse monthly data from 1996-2016 for the five EAC countries. The cointegration results support the existence of a long-run relationship between the tested variables, providing evidence for the optimum currency area (OCA) and the feasibility of monetary union in the EAC region. The VECM results indicate some differences in the size of the coefficients, suggesting that any change/shock of real exchange rate in the region may cause unintended currency flow from one country to the other in the short run, and this may constrain the possibility of an effective and efficient monetary union. Therefore, member countries should harmonise their monetary policies well ahead of the implementation of the monetary union the region.Keywords: East African Community, Monetary Union, GPPP, Optimum Currency Area.JEL Classifications: E42, F15, F31, F36, F45DOI: https://doi.org/10.32479/ijefi.11846

Unit of account, sovereign debt, and optimal currency area

This paper considers how the choice of a unit of account affects the formation of an optimal currency area (OCA). First, we show that forming a currency union internalizes the exchange rate risk and leads to smoothing of consumption levels. However, changing the unit of account of the inherited sovereign debt to a common currency may increase a country’s debt burden if a debtor country is more likely to face a trade deficit within the union. Therefore, the OCA is determined by this trade-off and the debtor country may be better off choosing not to enter the currency union when it faces a high inherited sovereign debt.

A new test for optimum currency area with an application to the Central and Eastern European countries

ABSTRACT This research introduces a new test for optimum currency area that is based on synchronization of monetary policy recommendations. The main advantage over the more traditional synchronization of business cycles is that it takes into account two known determinants of monetary policy: inflation and the output gap. As an application, the test is applied to the EU economies with a particular focus on the Central and Eastern European Countries. Some of these countries have recently joined the euro area, some are the members of ERM II, and the rest are debating whether to fulfill the convergence criteria of adopting the euro. The main findings are that within the last few years the current non-euro area members (with the exception of Bulgaria and Romania) fit the euro area as well as the core euro area countries.

Domestic price dollarization in emerging economies

This paper studies the dollarization of prices in retail markets of emerging economies. We develop a model of the firm’s optimal currency choice in retail markets in inflationary economies. We derive theoretical predictions regarding the optimality of dollar pricing, and test them using data from the largest e-trade platform in Latin America. Across countries, price dollarization is positively correlated with asset dollarization and inflation, and negatively correlated with exchange rate volatility. At the micro level, larger sellers are more likely to price in dollars, and more tradeable goods are more likely to be posted in dollars. We then show that the currency of prices determines the short-run reaction of both prices and quantities to a nominal exchange rate shock.

Frankel and Rose’s Introduction to the Endogeneity of Optimality: A Model Limited to the European Monetary Experience

This article discusses Frankel and Rose’s (1997, 1998) introduction to endogeneity, which was the result of scrutinizing the optimal currency area (OCA) theory through the evaluative lens of European monetary integration and unification in the 1990s. It cannot be generalized to another monetary union. The development of endogeneity interrelates five different criteria (common currency; transaction costs; commercial integration; economic convergence; and diversification of production) to argue that the introduction of a common currency leads to economic convergence among the participating countries. Frankel and Rose’s choice of analytic criteria arises from empirical studies on European monetary unification, following the OCA framework. The empirical studies found to have influenced the authors can be divided into three themes: the microeconomic benefits of a common currency; the optimality of European countries; and adjustment mechanisms. However, as shown by the selection of certain criteria, the influence of the Emerson report (1990), and the price-stability orientation of fiscal and monetary policies, their proposal only works within the monetary and economic conditions of the future eurozone area.

Will Bulgaria's Path to Eurozone Derail? A comparison with Argentina

In the wake of the prospects of Bulgaria joining the Euro area and the recent Eurozone crisis, it is pertinent to find out how parallel are the circumstances faced by the recent Bulgaria with the conditions of the then Argentina whose currency board had to be abandoned. In a nutshell, this paper compares Bulgaria in 2000-20101 to Argentina in 1991-2001, the period of the Argentine convertibility system. The dimensions explored are (1) adherence to currency board principles, (2) performance indicators associated with exchange rate fixity, and (3) conformity to the criteria inspired by the optimum currency areas (OCA) theory. Raw data are sourced from credible international organizations while computed data are analyzed using charts. On the whole, Bulgaria does bear a resemblance to Argentina and this poses a hindrance to the sustainability of its currency board system and to its hope for Eurozone accession.

Designing the fiscal-monetary nexus: policy options for the EU

In recent decades, and in particular since the shift towards independent central banks, there has been no explicit coordination of fiscal and monetary policy. In the Eurozone, this lack of coordination represents an important flaw, especially since the Eurozone is not an optimal currency area. Complementing monetary union with a transfer union represents one possible solution. This paper argues that the negative impact of post-2008 and post-Covid-19 unconventional monetary policy on income inequalities provides a second reason to coordinate fiscal and monetary policy. Among various institutional arrangements to implement such coordination, the paper defends the idea that the European Central Bank should be sensitive to distributive considerations when formulating its monetary policy. Such an arrangement would help both to contain the distributive side-effects of monetary policy and to at least partially remedy the flaw at the heart of the Eurozone as long as an outright transfer union remains unfeasible.

Empirical Study on the Prospects of Asean's Trade and A Single Currency

The paper seeks to explain the nature and prospects of trade and monetary integration in ASEAN during 1990-2017.Growth,structural breaks of Intra export and intra import shares of ASEAN including external trade were shown and influencing factors like GDP, FDI, REER,openness and inflation were regressed with them. Short run and long run causalities were observed among the said variables through cointegration and vector error correction models.Monetary integration was explained through capital market development especially in share and bond markets and in currency convertibility. Optimum currency area criterion was tested through Beta and Sigma convergence hypothesis which proved that the adoption of single currency in ASEAN is now not feasible.

SUBSTITUTION OF ANCHOR CURRENCY: CHALLENGES FOR TRADE BETWEEN IRAN AND ITS MAJOR TRADING PARTNERS

The aim of the paper is to find out whether euro is a convenient substitution for U.S. dollar as an anchor currency for Iranian rial and whether this replacement would affect Iran’s international trade positively. We explore these effects via Optimum Currency Area (OCA) theories using generalized least square from 2000 to 2018. Based on OCA index, euro would be a good substitution for U.S. dollar as an anchor for Iranian rial. In addition, gravity model and Generalized Method of Moments estimation confirm that substitution of U.S. dollar by euro would improve bilateral trade between Iran and its major trade partners especially the European Economic and Monetary Union (EMU). Furthermore, we confirm that a basket containing main currencies (euro, U.S. dollar, yuan, Russian rubble) would be more efficient than a single currency anchor however euro should be prominent in the basket. Such a change of anchor could positively contribute to reduction of transaction costs, diversification of external risk, rise of mutual trade exchanges between Iran and the EMU or the EU and consequent economic growth of trade partners. The paper contributes to the existing literature by comprehensive methodological approach how to identify an appropriate anchor currency.

Analysis of Single Currency Implementation in Asean+3

This research aims to analyze the feasibility of implementing single currency policy in ASEAN+3 countries based on annual data from 1993 to 2017. In this research, the panel data is analyzed using Pooled Least Square regression model and Moving Average forecasting method to predict optimum currency area indices of ASEAN+3 in the period of 2018 to 2022. The results showed that (1) ASEAN+3 region is not ready to implement single currency policy because of an increasing trend of asymmetric shock, lack of business cycle synchronization, and differences in production structure, trade relations, and economy size among ASEAN+3 countries. (2) There are four converged country pairs which mean higher feasibility of forming optimum currency area for the four country pairs; Brunei Darussalam and Singapore have the most symmetrical foreign exchange volatility among the other country pairs.

RECONSIDERING DINAR GOLD MONEY AS INTERNATIONAL TRADE CURRENCY: LITERATURE STUDY

It is common knowledge that the economic crisis is caused by the failure of paper money to maintain price stability, devaluation, and redistribution effects. Exchange rate fluctuations severely hamper international trade and finance. On the other hand, gold has a more stable exchange rate and is relatively exchangeable for various needs. Gold has the same intrinsic value as any other commodity. However, it can serve as an international unit or units of account. The funds can be used as settlements in international trade payments. In the context of the optimum currency area (OCA), trade barriers between countries are increasingly being removed, including forming a common currency. The use of gold as a form of union currency would facilitate payments and benefit member states. International payment arrangements can also be made within the framework of bilateral and multilateral payment agreements. We support the analytical model of Ahmed Kamel Mydin Meera which reveals that the gold dinar can replace the fiat money as a payment transaction, as well as as a settlement in international trade with a note after economic and monetary integration is formed.

Optimum Currency Area in Asean 5 Countries: Is it Appropriate to Use American Dollar As the Standar Currency?

Many times ASEAN countries experienced economic crisis in 1997/1998 and financial crisis in 2008. The similar patterns of cisis among those countries make some researchers conduct research of single currency unification. This research has a purpose to analyze the impact of ASEAN 5’s currencies (Rupiah, Ringgit, Singapore Dollar, Baht, and Peso) to a currency shock in the other ASEAN countries. The concept of this study uses the exchange rate approach pegged of ASEAN countries with American Dollars and Singapore Dollars. Furthermore, this research analyzes a symmetrical currency response to the currency shock in the other countries. The method of the study comes closer short-term and long-term models of Vector Auto regression (VAR) by using monthly data in real exchange rate variables from 1990 to 2019. The result of impulse response function (IRF) shows that responses to ASEAN currency pegged the currency to Singapore Dollars rather than US Dollars

Optimal Currency Allocation to Add Alpha and Reduce Risk

We propose a framework for optimal currency allocations taken relative to a strategic benchmark, which may build in existing hedging positions. We determine optimal currency positions to obtain higher expected returns than the benchmark holding the risk constant, or to reduce risk but hold the expected return of the benchmark constant, or both. The currency exposures relative to the strategic benchmark are considered jointly across all asset classes and currencies. We make the intuition explicit in a theoretical setting without constraints and empirically illustrate the framework with two portfolios: a representative portfolio for a Wealth manager denominated in Euros and a typical pension fund portfolio denominated in Pounds. Optimal currency allocations to reduce risk tend to hedge all or a significant fraction of currency exposures for both portfolios. We find certain hedges, like to Australian dollars for the Euro Wealth investor and Japanese Yen for the GBP pension portfolio, to be optimal to maximize returns with the same risk as the strategic benchmark.

The Portuguese escudo area in Africa and its lessons for monetary unions

ABSTRACT The beginnings of the Portuguese Escudo Monetary Zone (EMZ) in 1961, to promote the economic integration of Portugal and its empire, coincide in time with Mundell’s seminal paper about optimum currency areas. If non-optimality was the cause of the EMZ’s demise, this would suggest that monetary unions are fragile achievements, with little prospect for survival. The EMZ turned out to be a short-lived experiment, with Angola and Mozambique building up large cumulative deficit positions offset by the sizeable cumulative surpluses of the mainland. A cobweb model using monthly observations for macroeconomic variables of these two territories describes a time divergent process caused by structural imbalances, as well as by the loan granting system. The EMZ was not an optimum currency area and was not sustainable in the long run. This is an historical experiment that is not without interest for the study of other monetary areas.

Purchase of government bonds by a supranational central bank: its impact on business cycles

The euro area emerged from the euro crisis without meeting the conditions presented by the theory of optimum currency area. The decisive policy that ended this crisis was the Outright Monetary Transactions policy. Besides, the quantitative easing policy supports the economy of the euro area after this crisis. To examine the impact of these supranational monetary policies on the business cycles in the euro area, which is not covered by optimum currency area theory, we use a Kaldorian two-country model featuring a monetary union and imperfect capital mobility. We find that an increase in government bond purchases is a stabilizing factor, whereas an extreme increase in the degree of counter-cyclical fiscal policy is a destabilizing factor. Nevertheless, as long as the fiscal and monetary policies of two countries are not extremely active, but active to a certain extent, the equilibrium point becomes locally stable. Furthermore, even if the business cycles are not synchronized, the purchase of government bonds of a particular country is effective in stabilizing the business cycles of both countries. From these results, we suggest that the euro area satisfies the metacriteria of an optimum currency area through the implementation of a government bond purchase system by a supranational central bank system.

Dynamic Global Currency Hedging

Abstract This article proposes a model for discrete-time currency hedging based on continuous-time movements in portfolio and foreign exchange rate returns. The vector of optimal currency exposures is given by the negative realized regression coefficients from a one-period conditional expectation of the intraperiod quadratic covariation matrix for portfolio and exchange rate returns. Empirical results from an extensive hedging exercise for equity investments illustrate that currency exposures exhibit important time variation, leading to substantial volatility reductions when hedging, without sacrificing returns. A risk-averse investor is willing to pay several hundred annual basis points to switch from existing hedging methods to the proposed dynamic strategies.

Hedging with an Edge: Parametric Currency Overlay

We propose an optimal currency hedging strategy for global equity investors using currency value, carry, and momentum to proxy for expected currency returns. A benchmark risk constraint ensures the overlay closely mimics a fully hedged portfolio. We compare this with naïve and alternative hedges in a demanding out-of-sample test, with transaction and rebalancing costs and margin requirements. Other hedging methods generally reduce risk but at a cost. Some tend to short currencies with high returns and all incur substantial costs with frictions, mostly margin requirements and equity rebalancing costs. The proposed strategy uses predictable returns to reduce this cost. It produces a statistically significant 17% gain in Sharpe ratio and an annualized Jensen-α of 0.93% versus a fully hedged benchmark. Notably, most of the implementation costs of the strategy would be incurred by the benchmark anyway. This reduces its marginal cost and highlights a specific synergy of integrating hedging with speculation. This paper was accepted by Gustavo Manso, finance.

Dynamic measures of asymmetric & pairwise connectedness within an optimal currency area: Evidence from the ERM I system

This study introduces two novel metrics that calculate the degree of shock asymmetry which can be utilized to examine whether countries in a currency area face symmetric shocks. In an attempt to answer whether the symmetric shock assumption is fulfilled in the European case, the exchange rate transmission mechanism of all 14 countries that have joined the ERM and Sweden is explored. The findings point to the existence of two potential OCAs whereas the first and most stable one would be between Austria, Germany, and the Netherlands, and the extended second OCA would further include Belgium, Denmark, France, and Luxembourg.

Criteria of the optimal currency area: an empirical analysis

Using annual data of 37 countries for 2010-2018, the paper studies the relationship between the average GDP growth rate and several exogenous variables analyzed in the context of the Optimal Currency Area (OCA), such as openness for trade and capital flows, inflation and synchronization of the business cycles, based on the cross-section regression model. Similar relationships are estimated for the quarterly time series of Ukraine’s economy for 2010-2020. The paper argues that the GDP rate is positively related to both the openness to foreign trade and lower inflation, a result in line with the implications of the OCA theory. However, a similar stimulating effect of the capital inflows for Ukraine significantly differs from the opposite outcome obtained in the estimates of the cross-section regression for 37 countries. Our results mean that openness for trade is not excessive in Ukraine. While most countries have experienced a decline in the share of exports and imports in GDP since 2010, an upward trend in Ukraine, similar to the Central and Eastern European (CEE) countries, can be viewed in a favourable way. As there is an inverse relationship between the average GDP growth rate and initial GDP per capita, it is an argument in support of the neoclassical long-term growth models. It is clear that middle-income countries experience the convergence of income in line with the provisions of the neoclassical theory. However, net capital inflows do not play any role in the convergence process, thus rejecting one of the pillars of the neoclassical theory. For the cross-section estimates, no link between economic growth and business cycle synchronization with the main trade partner is detected. On the other hand, economic growth in Ukraine is closely related to the GDP dynamics in the Eurozone, being an extra argument in favour of the European integration process in general and the OCA theory in particular. It is worth noting that the exchange rate depreciation brings about a GDP slowdown in Ukraine. Such an outcome implies that any efforts to compensate for the worsening of the external conditions with an accommodating exchange rate policy seem to be counterproductive. Also, it argues in favour of stable exchange rate arrangements. In a conventional way, an increase in Ukraine’s lending rate is associated with a decrease in the GDP growth rate.

On Optimal Currency Areas and Common Cycles: Are the Acceding Countries Ready to Join the Euro?

The former EU president Jean-Claude Junker has proposed that all countries of the European Union should also adopt the euro as their currency and recent research has shown that countries currently pursuing this goal indeed fulfill the classical Optimal Currency Area (OCA) criterion of positively correlated shocks with the European Monetary Union (EMU). We illustrate, however, that not only the correlation of shocks but also a common impulse response pattern over time is needed for a currency area to be optimal. We test this additional OCA criterion using the concept of a common serial correlation test. The test clearly rejects the notion that the potentially acceding countries share a common cyclical response pattern with the EMU aggregate – except for Sweden. Instead, the business cycles in most of the other countries exhibit only a very weak form of codependence.