Does the euro dominate Central and Eastern European money markets?

Abstract

The so-called German Dominance Hypothesis (GDH) claimed that Bundesbank policies were transmitted into other European Monetary System (EMS) interest rates during the pre-euro era. We reformulate this hypothesis for the Central and Eastern European (CEE) countries that are on the verge of accessing the eurozone. We test this "Euro Dominance Hypothesis (EDH)" in a novel way using a global vector autoregressive (GVAR) approach that combines country-specific error correction models in a global system. We find that euro area monetary policies are transmitted into CEE interest rates which provides evidence for monetary integration between the eurozone and CEE countries. Our framework also allows for introducing global monetary shocks to provide empirical evidence regarding the effects of the recent financial crisis on monetary integration in Europe.

Euro Dominance Hypothesis and Monetary Policy Independence – the Czech Perspective

“…In other words, the results confirm the euro dominance hypothesis as the Euribor is very significant for the determination of Pribor in the long run. This result is in line with analyses done with different method (Kadow et al, 2013). Once the cointegrating vector was identified, the second part of monetary policy independence hypothesis consists of testing the weak exogeneity of Euribor in the VECM model.…”

“…Other explanation of this counter intuitive result relates to the data frequency. Usually the monthly data are used in analyses of longrun monetary convergence (Kadow et al, 2013). The monthly data for interest rates should portray the long-run relationships to a much greater extent (Hakkio, Rush, 1991) given the noise and jumps in daily interest rates volatility, and we conclude, that this is in fact the case.…”

“…To this end, we investigate the long-run relationship between Eurozone and Czech interest rates and analyse short run adjustment to this relation. We follow Camarerro and Ordonez (2001) and Kadow et al (2013) and use cointegrated VAR framework that allows for distinction between the long and the short run.…”

“…Therefore, the more appropriate technique would be to test for the weak exogeneity of Eurozone in the Czech interest rates setting. Kadow et al (2013) are using this method when constructing their model of Eurozone and CEE countries' interest rates and then testing validity of this assumption. In our research, we do not impose this assumption on our model prior to estimation.…”

“…In this paper, we follow the idea of Euro Dominance Hypothesis (EDH) proposed by Kadow et al (2013), who argue that the situation of non-euro EU countries with derogation in terms of euro is similar to the pre-euro situation of Eurozone countries and the European Mechanism System stability problem. In contrast to these authors, we investigate the problem of co-movement of interest rates in terms of costs of joining the EMU and the loss of the actual independence of domestic monetary policy in a small open economy.…”