European Monetary System Countries Research Articles

Fixed exchange rates with escape clauses: The political determinants of the European Monetary System realignments

This paper studies the political economy of realignments to fixed exchange rates and suggests that the use of realignments is less likely when there are political benefits from stable exchange rates and when linkages across other issue areas increase the costs of realignment. More specifically for the case of the European Monetary System (EMS), the expectation is that realignments are related to partisanship, support for the broader European integration, trade integration, resource transfers from the European Community, as well as countries reacting to the political and economic costs of realignment in other EMS members. Hypotheses are tested using binomial logit models on monthly data on exchange rate realignments for all EMS countries from 1979 to 1993. I find lower realignment risk for left wing policy-makers and countries with more trade links to Germany, whereas more intra-European Community resource transfers appear to go to countries facing higher realignment risk. Also, realignments are less likely when the rest of EMS member countries have stable international reserves and their governments are pro-European.

Dynamics of Intra-EMS Interest Rate Linkages

Anumber of previous studies have questioned the dominant role of Germany within the European Monetary System (EMS). These conclusions are often based on empirical findings that the interest rates of EMS member countries are not affected by German interest rates, even in the long run. In this study, we demonstrate that intra-EMS interest rate differentials (vis-a-vis Germany) exhibit mean-reverting behavior characterized by long-memory dynamics. In a system incorporating six EMS countries and one non-EMS country (the U.S.A.), estimates from a fractional error correction model suggest the presence of short-run intra-EMS monetary-policy interdependencies but validate the German Dominance Hypothesis in the long run.

European and international asymmetry in the volatility transmission mechanism: the “German Dominance Hypothesis” revisited

This paper re-examines the volatility transmission mechanism within the European Monetary System (EMS) and revisits the “German Dominance Hypothesis” using short-term interest rates. The results support German dominance within EMS, but not in a strict sense, since Germany’s short-term rates are also affected by its partners. When including the US interest rate, neither the German nor the US rate surface as predominant players in the volatility transmission mechanism. A final finding is absence of asymmetric behavior within EMS after Germany’s reunification due to the rapid convergence of the EMS countries as they prepared for monetary union.

Stochastic behaviour of Deutsche mark exchange rates within EMS

This article explores the intertemporal interaction of three European Monetary System (EMS) exchange rates namely, the French franc, the Belgian franc, and the Italian lira vis-a-vis the Deutsche mark from 1979 to 1999. The returns were examined using the multivariate moving average Exponential GARCH model, which is capable of accounting for potential asymmetries in the volatility transmission mechanism. The results point to significant and reciprocal volatility spillovers among markets before Germany's reunification in 1990. However, absence of spillovers and/or asymmetric behaviour of volatility is shown in the post-unification period. The 1990s witnessed a rapid process of macroeconomic convergence by the core EMS members and these actions substantially enhanced confidence about full monetary integration. Put differently, the EMS countries became better attuned to the business cycle and managed to significantly reduce consequential asymmetric shocks and thus exchange rate volatility.

Interest rate linkages within the European Monetary System: new evidence incorporating long-run trends

This paper shows that the rejection of the existence of bivariate long-run relationships between the interest rates within the European Monetary System (EMS), by previous studies, may stem from the under-specification of deterministic variables in the models and failure to capture the changes in the trend behavior of the data. The present study applies the Johansen cointegration tests in models with alternative trend specifications to four German-other EMS interest rate pairs for 1979–1998 with three sub-sample periods corresponding to different degrees of EMS monetary integration. In contrast to the findings of past studies, the results of this study lend support to the hypothesis that the interest rates of EMS countries move together more closely over time, converging from a wide dispersion toward the central level.

Generalized purchasing power parity and the case of the European Union as a successful currency area

This article uses multicountry purchasing power parity (PPP) tests to study the success of the European monetary system (EMS) in creating a successful currency area for a stable European monetary union. If the EMS has sufficiently integrated the fundamentals within the European Union, then real exchange rates between member countries will share a common stationary trend when denominated by a common outside currency. Previous research using two-country PPP tests have been inadequate in explaining the nonstationary nature of real exchange rates between the EMS countries and nonmember countries. The use of generalized PPP tests can show that even though individual exchange rates within the EMS may appear to be nonstationary with respect to outside countries, some of them will combine to form a currency union with a stable stationary trend.

Assessing the credibility of a target zone: evidence from EMS countries

This paper proposes a Bayesian extension of Svensson's (1991. IMF Staff Papers 38: 655–665) test of target zone credibility. The credibility measures considered allow us to quantify the target zone's overall credibility at each point in time as well as a measure of long-run credibility. In an application of the new methodology to three European Monetary System (EMS) countries (France, Italy and the UK), using data up to 1993, we find significant anticipatory signals of the September 1992 currency crisis. We also find a strong correlation between various macroeconomic variables and the proposed credibility measure. Copyright © 2000 John Wiley & Sons, Ltd.

Inflation and Uncertainty: Does the EMS Participation Play Any Role?

This paper examines whether European Monetary System (EMS) member ship has affected the link between inflation and inflation uncertainty. ARCH measures of conditional inflation volatility and Granger-causality tests for nine OECD countries over the period 1980-1994 indicate that in non-EMS coun tries -in these countries a monetary target seems to have been closely followedinflation seems to determine the behaviour of inflation uncert a i n t y. By con trast, in EMS countries ‐ these countries have geared their monetary policies to an exchange rate target ‐ inflation seems to have no impact on inflation uncertainty. This finding is probably due first, to the absence of any institution al restriction that characterises non-EMS membership, on the manner the monetary policy is pursued, and second, to the fact that under a monetary rule, any institutional or regulatory changes in the monetary sector are expected to fall more adversely upon inflation as well as inflation uncertainty. (JEL Classi fication: E31)

Macroeconomic determinants of long-term stock market comovements among major EMS countries

Long-term comovements of national stock markets in three EMS (European Monetary System) countries - France, Germany and Italy - are examined. The EMS stock markets are found to display long-term comovements governed by two common permanent components. To identify some interpretable sources of such long-term market comovements, the study explores whether they can be linked to similar comovements in macroeconomic variables, including the money supply, dividends and industrial production. Like stock prices, two common permanent components are found driving the comovements in each of these variables. Further analysis suggests that the long-term comovements in stock prices can be partly attributable to those in the macroeconomic variables, especially for the post-1987 period. The results confirm at least a limited role of these macroeconomic variables in accounting for the stock market comovements among the EMS countries.

Europe's monetary malaise: international institutions and domestic policy commitments

A yearlong nightmare for the European Monetary System (EMS) began in September 1992. Amid name–calling, finger–pointing, and hand–wringing, the British pound and the Italian lira dropped out of the Exchange Rate Mechanism (ERM). In succeeding months, virtually every other ERM currency came under attack.1 Three of them—the Spanish peseta, the Portuguese escudo, and the Irish punt—devalued within the system. Three others—the French franc, the Belgian franc, and the Danish krone—avoided devaluation, but only at the price of recurrent and costly rounds of intervention by multiple central banks. Finally, in August 1993, the defenders of the parities surrendered. The twelve EMS countries agreed to expand the fluctuation margins from 2.25 per cent on either side of parity (6 per cent for Spain, Portugal and the UK) to 15 per cent on either side of parity. The wider margins eliminated the potential for speculative attacks, but left the system only the thinnest veneer of exchange rate coordination. This article seeks not to assess the causes of the crisis but rather to explain why the EMS governments did not defuse it with a realignment—the mechanism built into the ERM for precisely such occasions.

Long-run purchasing power parity: evidence from some European Monetary System countries

Long-run purchasing power parity (PPP) for five countries participating in the European Monetary System (EMS) during the recent floating exchange rate period is studied. Using new econometric techniques, evidence is found supporting long-run purchasing power parity. Moreover, the long-run PPP relationship is generally stable throughout the period since the dissolution of the Bretton-Woods period, even with the advent of the European Monetary System. Frequent realignments within the EMS may have served to maintain competitiveness between member countries.

German unification and the European Monetary System: A quantitative analysis

This paper uses a macroeconomic model with rational expectations to analyze issues related to German unification. A principal focus of the paper is the effect of unification on member countries of the European Monetary System (EMS). Under certain conditions, German unification has a contractionary effect on other EMS countries. We explore the implications of alternative German fiscal and monetary policies for EMS and other countries.

Intramarginal intervention in the EMS and the target-zone model of exchange-rate behavior

Exchange-rate data produced by the European Monetary System (EMS) contradict important predictions made by the standard target-zone model. We show that the contradictions reflect a misinterpretation of policies pursued by the EMS countries. They intervened intramarginally, to keep exchange rates will within their bands, not at the edges of the bands, to keep rates from crossing them. In the Basle-Nyborg Agreement of 1987, however, they agreed to make fuller use of the band, and exchange rates behave differently thereafter. The effect appears clearly in the behavior of the French franc and less decisively in the behavior of the Italian lira. We conclude by examining and rejecting other explanations for the observed difference in exchange-rate behavior.

German dominance in the European Monetary System: Evidence from money supply growth rates

This paper presents further evidence on ostensible German dominance in the European Monetary System (EMS). A dynamic system of equations is built explaining money growth rates as a function of the EMS countries' money growth rates, the world money growth rate, exchange rate objectives, inflation rates, and real income growth rates. A test of German dominance based upon money growth rates is a test of the hypothesis that the EMS has increased the comovements of money demand between countries in the system. It is found that German independence holds, but other central banks can also be important players in the system in that they can conduct independent monetary policies. Monetary policies in the EMS are best characterized as interactive. Therefore, the strict German dominance hypothesis is rejected. It follows that the EMS has not increased significantly the link between money demand functions in the EMS countries in the “hierarchical” structure as claimed by the dominance argument.