Exchange rate and interest rate volatility in the European Monetary System: some further results

Abstract

The work of Artis and Taylor (1989a, 1994) is extended to examine the volatility of exchange rates and interest rates of countries participating in the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS). In particular, a test is undertaken for a shift in the volatility of nominal and real exchange rates across two sets of countries, an ERM group and a non-ERM group. A non-parametric technique reveals that a significant reduction in exchange rate volatility has occurred during the period of operation of the ERM across the member countries, providing further support to the idea of a ‘new’ and harder EMS in the second half of its operation. The exchange rate stability has not generated any ‘volatility transfer’ onto the interest rate. Nevertheless, the ‘new EMS’ 1986 effect, reported by Artis and Taylor, is rejected when the data series is lengthened.