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Exchange Rate Volatility and Choice of Anchor Currency - Prospects for a Melanesian Currency Union

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  • Willie Lahari

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    (Department of Economics, University of Otago)

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    Abstract

    This paper investigates an appropriate choice of anchor currency for a proposed Melanesian currency union under various hypothetical currency union arrangements. Drawing from the optimal currency area (OCA) theory and related extensions, the analysis focuses on the effects of a currency union on exchange rate volatility following similar approach by Scrimgeour (2002). Counterfactual exchange rate series are constructed for alternative scenarios for Melanesia with the following major trading partners: Australia, New Zealand, USA and Japan. The main findings showed that both short-term and cyclical exchange rate volatility are generally lower in a currency union with either Australia or New Zealand. However, the results vary under varying weights and currency baskets. Choosing a single common anchor currency based solely on exchange rate volatility may not be conclusive. Hence, further research is required, for example, in considering the effects of a currency union on volatility in output, inflation or interest rates.

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    File URL: http://www.business.otago.ac.nz/econ/research/discussionpapers/DP_1111.pdf
    File Function: First version, 2011
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    Bibliographic Info

    Paper provided by University of Otago, Department of Economics in its series Working Papers with number 1111.

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    Length: 32 pages
    Date of creation: Oct 2011
    Date of revision: Oct 2011
    Handle: RePEc:otg:wpaper:1111

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    Related research

    Keywords: Exchange Rate Volatility; Currency Union; Melanesian Countries;

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    References

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    1. Bayoumi, Tamim & Eichengreen, Barry, 1998. "Exchange rate volatility and intervention: implications of the theory of optimum currency areas," Journal of International Economics, Elsevier, vol. 45(2), pages 191-209, August.
    2. Marianne Baxter & Robert G. King, 1999. "Measuring Business Cycles: Approximate Band-Pass Filters For Economic Time Series," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 575-593, November.
    3. Fidrmuc, Jarko & Horváth, Roman, 2008. "Volatility of exchange rates in selected new EU members: Evidence from daily data," Economic Systems, Elsevier, vol. 32(1), pages 103-118, March.
    4. McKenzie, Michael D, 1999. " The Impact of Exchange Rate Volatility on International Trade Flows," Journal of Economic Surveys, Wiley Blackwell, vol. 13(1), pages 71-106, February.
    5. Meissner, Christopher M. & Oomes, Nienke, 2009. "Why do countries peg the way they peg? The determinants of anchor currency choice," Journal of International Money and Finance, Elsevier, vol. 28(3), pages 522-547, April.
    6. Scrimgeour, Dean, 2002. "Exchange rate volatility and currency union: New Zealand evidence," Journal of Policy Modeling, Elsevier, vol. 24(7-8), pages 739-749, November.
    7. Dean Scrimgeour, 2001. "Exchange rate volatility and Currency Union: Some theory and New Zealand evidence," Reserve Bank of New Zealand Discussion Paper Series DP2001/04, Reserve Bank of New Zealand.
    8. George S. Tavlas, 1993. "The ‘New’ Theory of Optimum Currency Areas," The World Economy, Wiley Blackwell, vol. 16(6), pages 663-685, November.
    9. Kawai, Masahiro & Takagi, Shinji, 2000. "Proposed strategy for a regional exchange rate arrangement in post-crisis East Asia," Policy Research Working Paper Series 2503, The World Bank.
    10. Masahiro Kawai, 2008. "Toward A Regional Exchange Rate Regime In East Asia," Pacific Economic Review, Wiley Blackwell, vol. 13(1), pages 83-103, 02.
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