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

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  • Willie Lahari

    (Department of Economics, University of Otago)

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.

Suggested Citation

  • Willie Lahari, 2011. "Exchange Rate Volatility and Choice of Anchor Currency - Prospects for a Melanesian Currency Union," Working Papers 1111, University of Otago, Department of Economics, revised Oct 2011.
    • Handle: RePEc:otg:wpaper:1111
    as

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    File URL: http://www.otago.ac.nz/economics/research/otago076669.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Exchange Rate Volatility; Currency Union; Melanesian Countries;
    All these keywords.

    JEL classification:

    • F15 - International Economics - - Trade - - - Economic Integration
    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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