Currency Substitution and Monetary Union: Evidence from Greece, Portugal and Spain Patterns in Neighboring Areas

This paper explores the effects of currency substitution behavior in Greece, Portugal and Spain in light of their upcoming participation in the European monetary Union. The cointegration methodology adopted leads to an error-correction model for each country which allows us to separate the short- and long-run effects of such behavior. Our findings reveal no significant currency substitution behavior in either country, at both the short- or long-run, suggesting that joining the union would offer them no real benefits since the presently needed monetary flexibility to combat inflation would be lost in such a union. This conclusion is not surprising given that these countries had not yet reached (by 1999) a level of economic convergence consistent with their advanced European patterns so as to an equal footing.