Exchange rates in european monetary integration

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Title: Exchange rates in european monetary integration
Author: Ranki, Sinimaaria
Organization: Suomen Pankki
Series: Bank of Finland studies. E
Series number: 9
Year of publication: 1998
Publication date: 1.1.1998
Pages: 221 s.
Keywords: ERM; EMS; valuuttakurssit; rahapolitiikka; euro; häiriöt; valuutat; opinnäytteet;
Abstract: Abstract This study, "Exchange Rates in European Monetary Integration", is an empirical contribution to exchange rate theory and international monetary cooperation.The first essay, "Realignment expectations in the ERM: 1987-1992", studies the five-year period of convergence and stability in the European Monetary System (EMS).Existing literature on target zones is utilized to model and estimate devaluation expectations.The results suggest that the exchange rates gained credibility towards the end of this five-year period. German Monetary Unification (GMU) initially had positive spill-over effects on partner countries.Later these effects reversed and the system became increasingly burdened by the consequences of high German interest rates. The second essay, "Monetary policy in the ERM: Internal targets or external constraints?", focuses on the role of the membership in the Exchange Rate Mechanism (ERM) as a determinant of monetary policy.We derive a monetary policy rule that trades off costs of interest rate instability against benefits from successful demand management and stable exchange rate in the ERM.The model is then used to interpret the empirical evidence from a VAR estimated on data from the member countries.The three main observations emphasized are the relatively stable role of the domestic variables, the declining importance of the foreign variables and the growing importance of domestic interest rate history as a determinant of monetary policy decisions. The content of the third essay, "On monetary policy in a bipolar international monetary system", focuses on the possible difficulties in reconciling a domestic inflation target with exchange rate stabilization when the currency is an international key currency.We analyse the international transmission of shocks, and the role of the exchange rate therein, within the framework of a model of two large symmetric open economies.The model's implications are then discussed in the context of the empirical evidence from a VAR estimated on data from Germany and the US.From the model's perspective, the inflation rate seems to be driven by domestic supply shocks in both countries.If the initial source of the disturbance is a US supply shock, Europe can stabilize the exchange rate only at the cost of domestic price stability. Alternatively, Europe has to let the exchange vary to sustain domestic price stability. Keywords: ERM, exchange rates, devaluation expectations, reaction function, monetary policy, international spillovers

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