tailieunhanh - Iceland’s currency options

This paper employs cointegration techniques to determine the degree of convergence of Iceland’s nominal interest rates and inflation rates with that of Canada and the Euro area. Nominal interest rates are used here as an indicator of financial market integration and inflation rates, a measure of monetary policy integration. | Journal of Applied Finance Banking vol. 4 no. 4 2014 73-83 ISSN 1792-6580 print version 1792-6599 online Scienpress Ltd 2014 Iceland s Currency Options Mustapha Ibn Boamah1 Abstract This paper employs cointegration techniques to determine the degree of convergence of Iceland s nominal interest rates and inflation rates with that of Canada and the Euro area. Nominal interest rates are used here as an indicator of financial market integration and inflation rates a measure of monetary policy integration. The degree of convergence of Iceland s inflation and nominal interest rates with the United States is also studied for comparison. The result of the test provides evidence in support of inflation rate convergence between Iceland and the Euro area. It also shows nominal interest rate convergence among all four countries. This result would contribute to the discussion on whether Iceland should join the European Union and European Monetary Union or adopt the Canadian dollar in a formal currency union if it chooses to abandon its currency. JEL classification numbers C22 C32 F33 F36 Key words Cointegration inflation interest rate monetary union currency union 1 Introduction As a small country with a freely floating low-volume world currency that has historically been volatile the question of an appropriate currency arrangement is an important one for Iceland more so following the financial crises and the near collapse of the Icelandic krona in October 2008. Much of the recent political debate in Iceland has been about a possible European Union EU and European Monetary Union EMU membership there has also been a growing debate about adopting a major currency such as the Canadian dollar. Many Icelanders who oppose EMU membership point to the relatively weak correlation of Iceland s business cycle with that of the Euro area compared with Canada which is also a resource rich nation with a similar monetary policy. There are also Icelanders who want less integration with the EU .