Work detail

The Evolution of Optimum Currency Area Index: Post-crisis Perspective

Author: Mgr. Pavlína Kadlecová
Year: 2016 - summer
Leaders: prof. Roman Horváth Ph.D.
Consultants:
Work type: CSF - Corporate Strategy and Finance
Masters
Language: English
Pages: 86
Awards and prizes:
Link: https://is.cuni.cz/webapps/zzp/detail/178383/
Abstract: This paper estimates the determinants of exchange rate variability for 21 developed economies
in 1980-1998. The results show that traditional criteria implied by the optimum currency area
(OCA) theory, such as business cycle synchronisation, trade linkages and economy size,
determine to a large extent bilateral exchange rate variability. Using the ordinary least squares
estimation, we compute OCA indices for European economies vis-à-vis Germany and identify
countries showing consistently large or little signs of convergence. We find that since 1998,
most European developed economies have converged to Germany whether or not they are using
the euro, suggesting that structural similarity is not driven solely by monetary integration. Our
results from the model estimated by the generalized method of moments suggest that two
additional criteria reflecting labour market flexibility and private credit growth are significant
in explaining the exchange rate variability and lead to a ranking of countries different from the
traditional approach. We find a positive relationship between the OCA indices and GDP decline
during the economic crisis of 2008-09, which further supports the view that the OCA index is
a useful indicator of the candidates’ readiness to join the Euro Area. We apply the results to the
countries of Central and Eastern Europe and conclude that countries which have already
adopted the euro are not those that would benefit the most from it, as predicted by the OCA
theory.
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