85th International Atlantic Economic Conference

March 14 - 17, 2018 | London, United Kingdom

Convergence process in the EMU: Optimum currency area index approach

Thursday, 15 March 2018: 10:10 AM
Jakub Frydrych, Ing. , Department of economic theories, Czech University of Life Sciences, Prague, Czech Republic
This paper evaluates the European monetary convergence in the period between 1999 and 2013. The main purpose of this contribution is to provide an overview of the current position of the European monetary convergence process from a different perspective than is usually considered for the theory of optimum currency areas (OCA). A generally accepted operationalization of the OCA theory is based on the research of Bayoumi, Eichengreen (1997), in which the nominal exchange rate (and its standard deviation) is used as a dependent variable. The issue of this model, which becomes more apparent with each new European Monetary Union (EMU) member, is that the sample of potential EMU members is getting smaller and will probably be significantly reduced in the next few years. Due to this technical issue, a relatively new approach has been proposed (SkoĊ™epa, 2011, 2013), which is using the real exchange rate as an endogenous variable. This model permits the inclusion of EMU member countries, which are omitted in the standard model, and therefore it is possible to draw conclusions about the evolution of the Euro area from a wider perspective. In the methodological approach, there is no difference between the estimation methods. Cross-sectional data for the 28 European countries are analyzed using the ordinary least squares estimate. Selection and calculation of variables precedes the econometric analysis, and those variables correspond to the basic characteristics of an optimum currency area. Although the dependent variable differs from the original research, an explanation of independent variables (synchronization of business cycles, similarity of production structure, intensity of mutual trade) is very much the same. An estimated model will later serve to calculate so-called OCA indexes, which express the proximity between two economic areas. Instead of the original interpretation focusing on the deviation of the nominal exchange rate, this paper introduces a model of appreciation of the real exchange rate.