Modeling the ECU Against the U.S. Dollar: A Structural Monetary Interpretation

The proposal that a reformed international monetary system be designed around currency blocs has gained some popularity of late. In Europe, the formation of the Euro formalizes the existence of a DM-based currency block. Little academic research has been conducted, however, on the properties of composite currencies such as the Euro. In this article, we examine the properties of the precursor to the Euro—namely, the ECU—against the U.S. dollar using a monetary framework. The article has several novel features: Our modeling strategy involves starting with underlying equilibrium conditions rather than a final reduced form; uses divisia money rather than the more conventional simple-sum money; interprets, in an economic sense, the long-run relationships; and produces an appealing forecasting performance.