To Join Or Not To Join A Currency Union? The Case Of Isreal

20/02/2007 |  Soffer Yoav
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To Join Or Not To Join A Currency Union? The Case Of Isreal
Yoav Soffer
Abstract
The paper quantitatively estimates the advantages and disadvantages for Israel in abandoning the shekel and joining either the dollar or euro block. As to the disadvantages, I present a review of OCA theory, according to which the presence of asymmetric shocks between the members of a currency union could cause difficulties due to the inability to apply differential monetary policies. This theory is implemented in the paper using the econometric technique developed by Blanchard and Quah (1989). I find a low correlation between the Israeli and European economies, although a similar correlation also exists among euro zone countries themselves. A somewhat higher correlation was recorded between Israel and the U.S. As to advantages, we follow the methodology of the "One Market One Money" (1992) study, and assess the potential savings which Israel could reap by abolishing currency exchange costs. Savings due to joining the dollar are fairly small, whereas in the case of joining the euro they are negligible, suggesting a possible upward bias that might exist in the "One Market One Money" estimates.
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