Jean Louis, Rosmy and Brown, Ryan and Balli, Faruk (2011): On the Feasibility of Monetary Union: Does It Make Sense to Look for Shocks Symmetry across Countries When None of the Countries Constitutes an Optimum Currency Area? Published in: Economic Modelling , Vol. vol 28, No. 6 (2011): pp. 2701-2718.
Download (514kB) | Preview
Usually, a monetary union is not considered feasible between countries if the correlations of shocks are positive but weak. This may not be so if the country with the larger output gap converges to full-employment equilibrium faster than the country with the smaller gap. We argue that common monetary policy can be destabilizing when countries’ responses to non-monetary shocks are perfectly symmetric with a correlation of 1 but exhibit differing investment sensitivities to the real interest rate. We use Canada, Mexico and the United States to test the feasibility of a monetary union by documenting whether: 1) gross investments in Canada and Mexico are equally responsive to the real fund rate, and 2) Canada’s and Mexico’s output growth and inflation respond differently to US monetary policy shocks and oil price shocks. This approach implicitly dictates whether the shocks themselves are symmetric or asymmetric. Using quarterly data and SVAR methodology, we conducted two layers of analysis. We estimated SVARs for the periods 1970–2008, 1970–1990 and 1991–2008 to find that a monetary union is feasible between Canada and the US for the first two sample periods. For Canada and Mexico, we find similar responses of output growth to US monetary policy shocks. We conducted further robustness tests by estimating two identified VARs with common US variables and oil prices for Canada and Mexico to assess commonality in responses to shocks with the US. These results affirm that a monetary union is also feasible between Canada and the US.
|Item Type:||MPRA Paper|
|Original Title:||On the Feasibility of Monetary Union: Does It Make Sense to Look for Shocks Symmetry across Countries When None of the Countries Constitutes an Optimum Currency Area?|
|English Title:||On the Feasibility of Monetary Union: Does It Make Sense to Look for Shocks Symmetry across Countries When None of the Countries Constitutes an Optimum Currency Area?|
|Keywords:||North American Monetary Union, US monetary policy shock, SVAR|
|Subjects:||C - Mathematical and Quantitative Methods > C3 - Multiple or Simultaneous Equation Models ; Multiple Variables > C32 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes ; State Space Models
F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F42 - International Policy Coordination and Transmission
F - International Economics > F3 - International Finance > F33 - International Monetary Arrangements and Institutions
|Depositing User:||Faruk Balli|
|Date Deposited:||10. Jul 2012 09:44|
|Last Modified:||18. Feb 2013 17:58|
Antia, Z., Djoudad, R. and St-Amant, P. (1999). Canada's exchange rate regime and north American economic integration: The role of risk-sharing mechanisms. Bank of Canada Working Paper No. 1999-17.
Arndt, S. (2006). Regional currency arrangement in North America. International Economics and Economic Policy, vol. 3(3), 265-280,
Asdrubali, P., Sorensen, B.E. and Yosha, O. (1996). Channels of interstate risk sharing: United States 1963-1990. Quarterly Journal of Economics, 111, 1081-1110.
Atkeson, A. and Bayoumi, T. (1993). Do private capital markets insure regional risk? Evidence from the United States and Europe. Open Economies Review, 4, 303-324.
Bache, I. W. and K. Leitemo (2008) ‘The Price puzzle: mixing the temporary and permanent monetary policy shocks.’ Working Paper available at http://www.bof.fi/NR/rdonlyres/DAEF2D54-0DAF-48E5-9014-8A9A4F13D03F/0/Leitemo_May2009.pdf
Balli, F., S. Basher, and R. Jean Louis (2011). Channels of risk-sharing among Canadian provinces: 1961-2006. Empirical Economics forthcoming.
Barth, M. J., and V. A. Ramey (2001) The cost channel of monetary transmission in B.S. Bernanke and K. Rogoff, (eds), NBER Macroeconomic Annual, MIT Press Cambridge, MA 199-239.
Bayoumi, T. and Eichengreen, B. (1994). Monetary and exchange rate arrangements for NAFTA. Journal of Development Economics, 43, 125–65.
Bayoumi, T. and Masson, P.R. (1995). Fiscal flows in the United States and Canada: Lessons for monetary union in Europe. European Economic Review, 39, 253-74.
Bayoumi, T. and A. Swiston (2007). Foreign entanglements: estimating the source and size of spillovers across industrial countries. IMF Working Paper WP/07/182.
Beare, J. B. (1976). A monetarist model of regional business cycles. Journal of Regional Science, 16, 57–63.
Bernanke, B. (1986). Alternative explanations of the money-income Correlation. Carnegie-Rochester Conference Series on Public Policy, 25, 49–99.
Bernanke, B. S. and A. S. Blinder (1992). The federal funds rate and the channels of monetary transmission. The American Economic Review, 82, 901-921.
Blanchard, O. J. and D. Quah (1989). The dynamic effects of aggregate demand and supply Disturbances. The American Economic Review, 79, 655-673.
Bhuiyan, R. (2008). Monetary transmission mechanism in a small open economy: a bayesian structural VAR approach. Queen’s Economics Department Working Paper No. 1183.
Britton, E. and Whitley, J. (1997). Comparing the monetary transmission mechanism in France, Germany and the United Kingdom: some issues and results. Bank of England Quarterly Bulletin, 37, 152–62.
Carlino, G. and DeFina, R. (1998). The differential regional effects of monetary policy. The Review of Economics and Statistics, 4, 572–87.
Carlino, G. and DeFina, R. (1999). Do states respond differently to changes in monetary policy? Business Review, July, 17–27
Carr, J. and J. Floyd (2008). Real and monetary shocks to the Canadian Dollar: do Canada and the US Form an Optimal Currency Area? Working Paper No: UT-ECIPA-Floyd-01-02. Department of Economics and Institute for Policy Analysis, University of Toronto.
Chowdhury, I., M. Hoffmann, and A. Schabert (2006). Inflation dynamics and the cost channel of monetary transmission. European Economic Review, 50, 995-1016.
Christiano, L. J., M. Eichenbaum, and C. L. Evans (1999). 'Monetary policy shocks: what have we learned and to what end?’, in J. B. Taylor, and M. Woodford (eds.), Handbook of Macroeconomics, Vol. 1A, Elsevier Science, pp. 65-148.
Clausen, V. and Hayo, B. (2006). Asymmetric monetary policy effects in the EU. Applied Economics, 38, 1123–34.
Cogley, T. and T. Sargent (2001). Evolving Post-World War II US inflation dynamics. Working Paper.
Cooley, T. F. and S. F. Leroy (1985). A theoretical macro econometrics: a critique. Journal of Monetary Economics, 16, 283-308.
Cooley, T. F. and V. Quadrini (2001). The costs of losing monetary independence: the case of Mexico. Journal of Money, Credit, and Banking. 33, 370-397.
Cuevas, A., Messmacher, M., and A. Werner (2003). Sincronización macroeconómica entre México y sus socios momerciales del TLCAN. Working Paper 2003-1 Banco de México.
Cushman, D. O. and Zha, T., (1997). Identifying monetary policy in a small open economy under flexible exchange rates. Journal of Monetary Economics, vol. 39, 433-448.
Del Negro, M. and F. Obiols-Homs (2001). Has monetary policy been so bad that it is better to get rid of it? The case of Mexico. Journal of Money, Credit, and Banking, 33 404-433.
Dornbusch, R., Favero, C. A. and Giavazzi, F. (1998) A red letter day?, CEPR Working Paper No. 1804.
Enders, W. (2004) Applied Econometric Time Series. Wiley, 2nd Edition.
Fernandez, V. and A. Kutan (2005). Do regional integration agreements increase business cycle convergence? Evidence from APEC and NAFTA. William Davidson Institute Working Paper 765.
Fortin, P. (1996). The Great Canadian slump. The Canadian Journal of Economics, 29, 761-787.
Galí, J. (1992). How well does the IS-LM model fit postwar US Data? The Quarterly Journal of Economics, 107, 709-738.
Georgopoulos, G. (2009). Measuring regional effects of monetary policy in Canada. Applied Economics, 41, 2093–2113.
Gertler, M. and Gilchrist, S. (1993). The role of credit market imperfections in the monetary transmission mechanism: arguments and evidence. Scandinavian Journal of Economics, 95, 43–64.
Gertler, M. and Gilchrist, S. (1994). Monetary policy, business cycles and the behaviour of small manufacturing firms, Quarterly Journal of Economics, 109, 309–40.
Giordani, P. (2004). An alternative explanation of the price puzzle. Journal of Monetary Economics, Vol. 51, 1,271-96.
Hanson, M. S. (2004) ‘The price puzzle reconsidered’ Journal of Monetary Economics, 51, 1,385-413.
Hernandez, J. (2004). Business cycles in Mexico and the United States: do they share common movements. Journal of Applied Economics, 7, 303-323.
Holman, J. and R. Neumann (2002). Evidence on the cross-country transmission of monetary shocks. Applied Economics, 34, pp. 1837-1857.
Jean Louis, R., M. Osman, and F. Balli (2010a). Is the US Dollar a suitable anchor for the newly proposed GCC Currency? The World Economy Journal 33, (12) pp. 1898–1922.
Jean Louis, R., F. Balli, and M. Osman (2010b). On the feasibility of monetary union among Gulf Cooperation Council (GCC) countries: does the symmetry of shocks extend to the non-oil sector? Journal of Economics and Finance, Springer, vol. 36(2), pages 319-334
Jean Louis, R. and D. Simons (2007). Is there a North American business cycle? An analysis of the period 1963-2002. Applied Econometrics and International Development, 7, 109-120.
Kenen, P. B. (1969). The theory of optimum currency areas: an eclectic view. In R. A. Mundell and A. K. Swoboda, Monetary Problems of the International Economy, University of Chicago Press, pp 41-60.
Kilian, L. (2009). Not all oil price shocks are alike: disentangling demand and supply shocks in the crude oil market. American Economic Review, 99, 1053-1069.
Kilian, L., and C. Vega (2010). Do energy prices respond to US macroeconomic news? A test of the hypothesis of predetermined energy prices. Review of Economics and Statistics Vol. 93, No. 2, Pages 660-67.
Klyuev, V. (2008). Real implications of financial linkages between Canada and the United States. IMF Working Paper, August.
Kose, A. and R. Cardarelli (2004). Economic integration, business cycle, and productivity in North America. International Monetary Fund Working Paper 04/138.
Leeper, E. M. and J. Roush (2003). Putting ‘M’ back in monetary policy. Journal of Money, Credit and Banking, Vol. 35, 1,217-56.
Levine, R. and M. Carkovic (2001). How much bang for the buck? Mexico and Dollarization. Journal of Money, Credit and Banking, 33,339-363.
McKinnon, R. I. (1963). Optimum currency areas. American Economic Review, 53, 717-725.
Michelis, L. (2004). Prospects of a monetary union in North America: an empirical investigation, in Exchange Rates, Economic Integration, and the International Economy, Ed. Michelis, L., Lovewell, M.
Mundell, R. A. (1961) A theory of optimum currency areas. American Economic Review, 51, 657-665.
______________(1973). Uncommon arguments for common currencies, in H.G. Johnson and A.K. Swoboda, The Economics of Common Currencies, Allen and Unwin, 1973. pp.114-32.
______________(1973). A Plan for a European Currency”, in H.G. Johnson and A.K. Swoboda, The Economics of Common Currencies, Allen and Unwin, 1973. pp. 143-72.
Murray, J. (2000). Revisiting the case for a flexible exchange rate in Canada. Speech presented at the North-South Institute Conference on Dollarization in the Western Hemisphere, October.
Murray, J., Schembri, L., and P. St-Amant (2003). Revisiting the case for flexible exchange Rates in North America. The North American Journal of Economics and Finance, 14, 207-240.
Oliner, S. D. and Rudebusch, G. D., (1996). Monetary policy and credit conditions: evidence from the composition of external finance: comment. American Economic Review, 86, 300-309.
Ponce, R. and R. Acosta (2008). Economic integration in North America. Applied Econometrics and International Development, 8, 111-122.
Ramos, R., Clar, M. and Surinach, J. (2003) A dynamic analysis of asymmetric shocks in EU manufacturing. Applied Economics, 35, 881–92
Sims, C. A. (1980). Macroeconomics and reality. Econometrica, 48, 1-48.
_________________ (1986). Are forecasting models usable for policy analysis? Federal Reserve Bank of Minneapolis Quarterly Review, 2-15.
_________________ (1992). Interpreting the macroeconomic time series facts: the effects of monetary policy. European Economic Review, 36, 975-1011.
Stock, J. and M. Watson (1993). A simple Estimator of co-integrating vectors in higher-order integrated systems. Econometrica, 3, 783-820.
Swiston, A.and T. Bayoumi (2008). Spillovers across NAFTA. IMF Working Paper WP/08/3.
Torres, A. and O. Vela (2003). Trade integration and synchronization between the business cycles of Mexico and the United States. North American Journal of Economics and Finance, 14, 319–342.
Tower, E. and T. D. Willett (1976). The theory of optimum currency areas and exchange rate flexibility. Special Papers in International Economics, No. 11. International Finance Section, Department of Economics, Princeton University.