What If the UK Had Joined the Euro in 1999? An Empirical Evaluation Using a Global VAR

58 Pages Posted: 11 Jun 2005

See all articles by M. Hashem Pesaran

M. Hashem Pesaran

University of Southern California - Department of Economics; University of Cambridge - Trinity College (Cambridge)

Ron Smith

Birkbeck College

L. Vanessa Smith

University of York - Department of Economics and Related Studies

Date Written: June 2005

Abstract

This paper attempts to provide a conceptual framework for the analysis of counterfactual scenarios using macroeconometric models. As an application we consider UK entry to the euro. Entry involves a long-term commitment to restrict UK nominal exchange rates and interest rates to be the same as those of the euro area. We derive conditional probability distributions for the difference between the future realisations of variables of interest (e.g UK and euro area output and prices) subject to UK entry restrictions being fully met over a given period and the alternative realisations without the restrictions. The robustness of the results can be evaluated by also conditioning on variables deemed to be invariant to UK entry, such as oil or US equity prices. Economic interdependence means that such policy evaluation must take account of international linkages and common factors that drive fluctuations across economies. In this paper this is accomplished using the Global VAR recently developed by Dees, di Mauro, Pesaran and Smith (2005). The paper briefly describes the GVAR which has been estimated for 25 countries and the euro area over the period 1979-2003. It reports probability estimates that output will be higher and prices lower in the UK and the euro area as a result of entry. It examines the sensitivity of these results to a variety of assumptions about when and how the UK entered and the observed global shocks and compares them with the effects of Swedish entry.

Keywords: Global VAR (GVAR), Counterfactual Analysis, UK and Sweden entry to euro

JEL Classification: C32, C35, E17, F15, F42

Suggested Citation

Pesaran, M. Hashem and Smith, Ron P. and Smith, L. Vanessa, What If the UK Had Joined the Euro in 1999? An Empirical Evaluation Using a Global VAR (June 2005). Available at SSRN: https://ssrn.com/abstract=740424

M. Hashem Pesaran (Contact Author)

University of Southern California - Department of Economics

3620 South Vermont Ave. Kaprielian (KAP) Hall 300
Los Angeles, CA 90089
United States

University of Cambridge - Trinity College (Cambridge) ( email )

United Kingdom

Ron P. Smith

Birkbeck College ( email )

Malet Street
London WC1E 7HX
United Kingdom
+44 207 631 6413 (Phone)
+44 207 631 6416 (Fax)

L. Vanessa Smith

University of York - Department of Economics and Related Studies ( email )

Heslington
University of York
York, YO10 5DD
United Kingdom

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