Euro-Dollar

Assignmemt Three - Due Date December 13th Jaime Marquez SAIS

Fall 2014

Jaime Marquez (SAIS)

Fall 2014

1/7

Question: Will the Euro Surpass the Dollar?

Menzie Chinn and Je¤ Frankel argue that the Euro may surpass the Dollar They made this prediction in 2008 At that time, they were predicting a lapse of 15 years for the Euro to surpass the dollar The third assignment is to assess the reasonableness of this prediction The raw data are in an excel …le in Blackboard http://www.hks.harvard.edu/fs/jfrankel/Euro&ResChinn&F2008IF.pdf

Jaime Marquez (SAIS)

Fall 2014

2/7

What is the factual basis for this view? Share of US dollars 70

60

50

40

30

Share of E uros

20

sourc e: IMF's coffe r 20 00

Jaime Marquez (SAIS)

20 05

20 10

20 15

Fall 2014

3/7

Approach I: Time series extrapolations

1 2 3

4 5 6

Regress the logit share of each currency on a time trend Extrapolate the …tted equations into the future Find the date when the share of dollars is below the share of euros. Is this date consistent with the prediction of Chinn and Frankel? If yes, then there is a presumption. If not, pursue Approach II

Jaime Marquez (SAIS)

Fall 2014

4/7

Approach II: Extrapolations of Economic Determinants Chinn and Frankel (p. 61) argue that currency shares depend on Relative size of the countries (e.g., US GDP/World GDP) In‡ation di¤erentials Depreciation Exchange rate variability Persistence

A satisfactory assessment is beyond the time allowed As an alternative, the currency shares might be modeled as a function of US long-term (10-year) interest rate German long-term (10-year) interest rate Share of US imports of goods and services in world’s imports Jaime Marquez (SAIS)

Fall 2014

5/7

Approach II: Estimation Logit of dollar share 10 10 + φ$ Re,t L$,t = α$ + β$ Sus,t + µ$ Rus,t

(+)

(+)

( )

Logit of euro share 10 10 Le,t = αe + βe Sus,t + µe Rus,t + φe Re,t

( )

( )

(+)

Li ,t logit share of the ith currency

St =

Mus ,t Mworld ,t ; Mus,t

US imports; Mworld ,t world imports

(sign) a-priori sign of the coe¢ cient Is the …t of model good enough to address the question? Jaime Marquez (SAIS)

Fall 2014

6/7

Approach II: Extrapolation Logit of dollar share 10 10 b b $ Rus,t Lb$,t +h = b α$ + b β$ Sus,t +h + µ +h + φ$ Re,t +h (+)

(+)

( )

‘b ’estimated value Extrapolate the paths for the predetermined variables: Sus,t +h , 10 10 Rus,t +h , Re,t +h Forecast horizon period :from 2014Q1 to 2023:Q4 h = 1, 2 , 40 Apply the same logic to the logit of the euro share Scenario Analysis: How sensitive are the results to the assumed forecasts? Is the share of the dollar by 2023 lower than the share of the euro across all scenarios? If yes, then the evidence is consistent with Chinn and Frankel Jaime Marquez (SAIS)

Fall 2014

7/7