Skip to main content
SpringerLink
Log in

Economic integration and the foreign exchange

  • Original Paper
  • Published:
International Economics and Economic Policy Aims and scope Submit manuscript

Abstract

This paper demonstrates effects of economic convergence processes on the foreign exchange behaviour in a monetary modelling approach. Since the exchange rate represents the relative price of two currencies, commonness of stochastic trends between the fundamental determinants of supply and demand of the underlying monies restricts exchange rate movements to transitory fluctuations. In the spirit of optimal currency areas, this has the potential to serve as a criterion for an all-round integration of two economies. Empirically, such a constellation is found between Australia and New Zealand, whereas diverging trends in money and interest rates characterise the relation of Australia towards the US.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2

Similar content being viewed by others

Notes

  1. For further interpretation on the role of inflation, see Goldfeld and Sichel (1987).

  2. Without applying such a common measuring unit, for instance cointegrating vectors of (1, − 1) would not be meaningful.

  3. Further tests for the first differences showed that money could be borderline I(2). Since with I(1) inflation prices are as well I(2), real money can become I(1) by the long-run price homogeneity assumed in Eqs. 1 and 2.

  4. While a linear trend was statistically significant in the ADF test for the GDP spread, its size is economically irrelevant and therefore does not cast doubt on the hypothesis of income convergence.

  5. The specification of the underlying model is discussed in the following.

  6. A linear trend in first differences implies a quadratic trend in levels, which is clearly not adequate for exchange rates. While the trend should thus be restricted to the cointegrating relations, doing without this constraint for simplicity does not change the empirical results.

  7. Note however, that such statements on causality are naturally based on the considered information set; Australia is not likely to be the only essential factor for New Zealand.

  8. Again, the linear trend is economically irrelevant.

  9. Taking M3 instead of M1 does not change this result. Note that although money could again be borderline I(2), the spread emerges as I(1). However, no evidence of polynomial cointegration could be found.

  10. This means adding s t − 1 on both sides of Eq. 8.

  11. Again, bear in mind the annualisation.

References

  • Ball L (2001) Another look at long-run money demand. J Monet Econ 47(1):31–44

    Article  Google Scholar 

  • Bernard AB, Durlauf SN (1995) Convergence in international output. J Appl Econ 10(2):97–108

    Article  Google Scholar 

  • Cheung YW, Chinn MD, Pascual AG (2005) Empirical exchange rate models of the nineties: are any fit to survive? J Int Money Financ 24(7):1150–1175

    Article  Google Scholar 

  • De Grauwe P, Grimaldi M (2006) Exchange rate puzzles: a tale of switching attractors. Eur Econ Rev 50(1):1–33

    Article  Google Scholar 

  • Dornbusch R (1976) Expectations and exchange rate dynamics. J Polit Econ 84(6):1161–1175

    Article  Google Scholar 

  • Frankel JA (1979) On the mark: a theory of floating exchange rate based on real interest differentials. Am Econ Rev 69(4):610–627

    Google Scholar 

  • Goldfeld SM, Sichel DE (1987) Money demand: the effects of inflation and alternative adjustment mechanisms. Rev Econ Stat 69(3):511–515

    Article  Google Scholar 

  • Johansen S (1995) Likelihood-based inference in cointegrated vector autoregressive models. Oxford University Press, Oxford

    Book  Google Scholar 

  • MacDonald R, Taylor MP (1991) The monetary approach to the exchange rate: long-run relationships and coefficient restrictions. Econ Lett 37(2):179–185

    Article  Google Scholar 

  • Meese RA, Rogoff K (1983) Empirical exchange rate models of the seventies: do they fit out of sample? J Int Econ 14(1–2):3–74

    Article  Google Scholar 

  • Moersch M, Nautz D (2001) A note on testing the monetary model of the exchange rate. Appl Financ Econ 11(3):261–268

    Article  Google Scholar 

  • Saikkonen P, Lütkepohl H (2002) Testing for a unit root in a time series with a level shift at unknown time. Econom Theory 18(2):313–348

    Article  Google Scholar 

  • Weber E (2012) Regional and outward economic integration in south-east asia. Appl Econ 44(10):1271–1283

    Article  Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Universität Regensburg, 93040, Regensburg, Germany

    Enzo Weber

  2. Institute for Employment Research (IAB), Nuremberg, Germany

    Enzo Weber

Authors
  1. Enzo Weber
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Enzo Weber.

Additional information

This research was supported by the Deutsche Forschungsgemeinschaft through the CRC 649 “Economic Risk”. I am grateful to two anonymous referees and Cordelia Thielitz for their comments. Of course, all remaining errors are my own.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Weber, E. Economic integration and the foreign exchange. Int Econ Econ Policy 10, 201–215 (2013). https://doi.org/10.1007/s10368-011-0202-3

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10368-011-0202-3

Keywords

JEL Classification

Search

Navigation