Tuesday, October 18, 2011

BB - Currency blocs in the 21st century

Currency blocs in the 21st century
Christoph Fischer

Discussion Paper
Series 1: Economic Studies
No 12/2011

"Based on a classification of countries and territories according to their regime and anchor currency choice, the study considers the two major currency blocs of the present world. A nested logit regression suggests that long-term structural economic variables determine a given country’s currency bloc affiliation. The dollar bloc differs from the euro bloc in that there exists a group of countries that peg temporarily to the US dollar without having close economic affinities with the bloc. The estimated parameters are consistent with an additive random utility model interpretation. A currency bloc equilibrium in the spirit of Alesina and Barro (2002) is derived empirically."

"...With regard to the first of these questions, the study finds that the number of countries and territories that belong to either of the two blocs was the same in 2008. In terms of combined GDP measured in purchasing power parities, the US dollar bloc is around double the size of the euro bloc. This changes considerably, however, as soon as China de-pegs its currency, the renminbi, from the dollar. In contrast to the euro bloc, there is a high degree of fluctuation into and out of the dollar bloc...."

"...As regards the second set of questions, the results of a nested logit regression suggest that long-term structural economic variables significantly explain the choice between a floating and a fixed exchange rate regime and, at the same time, the anchor currency choice given that a country has opted for a peg. Trade integration plays a major role in a country’s anchor currency choice in the case of both the dollar and the euro bloc. The distance to the location of the central monetary authority of the two blocs, Washington, DC, and Frankfurt am Main, respectively, is a significant factor for anchor currency choice with regard to the euro bloc, but not to the dollar bloc. This might imply that the US dollar is of global importance as an anchor currency and that the euro is not. Separate regressions qualify such a conclusion, however, by showing that this result is entirely due to a group of countries that peg their currencies only temporarily to the US dollar..."

"...Addressing the third set of questions, the study computes a currency bloc equilibrium in which all countries have adopted the utility-maximising exchange rate regime and anchor. It is found that, in equilibrium, the US dollar bloc is smaller and the euro bloc is larger than at present. The equilibrium is characterised by several Asian and African countries having de-pegged from the US dollar and by additional European countries having adopted a fixed exchange rate to the euro. Moreover, the calculations suggest that, structurally, the potential for the formation of a renminbi bloc is low..."


"...6.2.2 Oil-exporting countries stop using the US dollar as invoice currency
Currently, the US dollar is used as the invoice currency for oil exports. In recent years, there have been discussions in some countries about whether this could or should be changed. Until now, a majority of OPEC countries have rejected the idea (cf Eichengreen, 2011, p 123). Nevertheless, Khan (2009) reports for the Middle East,
where many countries peg their currencies to the dollar and, at the same time, are net oil exporters, that “there is considerable discussion in the region about reducing the dominance of the dollar and increasing the relative importance of the euro” (p 139). In an analysis of this issue, Louis et al (2010) find that an anchor to a currency basket may be superior to a dollar peg for the countries of the Gulf Cooperation Council. It may therefore be of interest to investigate the repercussions of a counterfactual in which oilexporting countries stop using the dollar as the invoice currency. Technically, this has been done, first, by setting the parameters of the percentage of oil in total exports and its variances and covariances to zero and, then, re-computing the new currency bloc equilibrium.
Since the significance of the net oil export parameters in the baseline estimates is weak at best, it might be expected that the counterfactual arrives at virtually the same equilibrium as the baseline scenario. Such a conjecture is supported by the results for the pooled estimates, where the switch in invoice currency simply raises Azerbaijan’s estimated utility gain of de-pegging its currency from the dollar to significant levels. Moreover, Chad has chosen to float its currency instead of pegging it to the US dollar in the new counterfactual equilibrium. When the 2008 data estimates are used, the repercussions of a change in the oil trade invoice currency are more severe. The new counterfactual equilibrium differs from the baseline equilibrium by the fact that not only Azerbaijan has chosen to de-peg its currency from the dollar and let it float but also Ecuador, Kazakhstan and Saudi Arabia. Angola is computed to switch directly from the US dollar to the euro bloc...."

"...6.2.3 Former colonial ties no longer bind
In the estimations, the parameter of the dummy for former dependency on one of the euro bloc countries is highly significant. However, for most countries, several decades have passed since they obtained political independence. Network effects will have played a role in maintaining ties between former colony and colonial power. The counterfactual of this section assumes that these ties no longer bind. Technically, a new equilibrium is computed much like in the previous section after having set the parameter and covariances of the colony dummy to zero. In the resulting counterfactual equilibrium, nearly all the African countries that presently peg their currencies to the euro have left the euro bloc.18 Most of these countries have adopted a regime of flexible exchange rates. The Republic of the Congo and Gabon, both of which are net oil exporters, have switched directly from a euro peg to a dollar peg..."

[Mrt: It would be great to see an overview of countries which obtained gold during the described time-frame and how they have managed their reserve asset portfolio.]

Source: http://www.bundesbank.de/download/volkswirtschaft/dkp/2011/201112dkp.pdf

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