Can South America form an optimal monetary area? A structural vector autoregression analysis
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Can South America form an optimal monetary area? A structural vector autoregression analysis León Padilla 1
& Ángel
Rodriguez García-Brazales 2
Accepted: 28 October 2020/ # The Author(s) 2020
Abstract This research analyzes the feasibility of adopting a common currency in South America using the Optimal Monetary Areas theory. Taking into account that the relative dominance of regional shocks in local output is considered a key indicator to adopt a regional currency, we use a structural vector autoregression (SVAR) model to determine what type of shock —among global, regional or country specific— prevails in South American economies. The results of variance decomposition demonstrate that the output trajectory of South American countries is mainly explained by countryspecific shocks; therefore, South America as a whole is not considered not an optimal monetary area. However, we identified a group of countries —named Sud-5 (comprised of Chile, Peru, Ecuador, Brazil and Argentina)— for which the costs of a hypothetical monetary union would be relatively lower. Keywords South America . Common currency . SVAR . Variance decomposition JEL classification F33 . F36 . F41 . F45
* León Padilla [email protected] Extended author information available on the last page of the article
L. Padilla, Á. R. García-Brazales
1 Introduction Recent changes in the International Monetary System (IMS)1 have led several economies to adopt regional currencies, as is the case for the euro area and the recent Monetary Area in the West African (ECOWAS) project. This scenario may have an impact on the debate about regional currencies in other economic blocs. In the case of South America (SA), the debate started with the work of Bayoumi and Eichengreen (1993), who found little support for the idea of a common currency area. Further contributions corroborate this result, with the last relevant work being that of Larrain and Tavares (2003) and the recent paper of Hafner and Kampe (2018). However, after more than twenty-five years of an unprecedented process of globalization, the case for a monetary union in SA should be revisited. One of the main obstacles to economic integration is the reluctance of the majority of countries to forgo their sovereignty in order to achieve more regional cohesion (Dutta et al. 2020). In a global context, most researchers agree that Latin American (LA) economies maintain a low level of integration. Using a set of indicators of economic integration —suggested by the optimum currency area theory (OCA)—, Dorrucci et al. (2004) showed that LA was less economically integrated not only than the European Union (EU) after the adoption of the euro, but in some cases even less than the EU at the beginning of its regional integration process in the 1960s. East Asia, even with their relative lack of formal regional trade treaties, is more integrated among itself than the countries within LA (Aminian et al. 2009). Reyes et al. (2010) explained that the lower degree of integration of LA could be related to
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