EVALUATING THE EMPIRICAL-EVIDENCE FOR CURRENCY SUBSTITUTION - A CASE-STUDY OF THE DEMAND FOR STERLING IN EUROPE

Currency substitution has important implications for the cost of Europ ean monetary union - if it is significant it will help to reduce costs of convergence to a single currency. This paper informs the policy de bate by testing for its existence on a consistent European database ma king use of cointegration methods. The results demonstrate that in the two types of model tested there is no clear evidence of currency subs titution, in either the short of the long run, and that therefore curr ency substitution between sterling and EC currencies cannot be relied upon as a mechanism or an aid to reduce the costs of monetary converge nce.