An empirical examination of exchange-rate credibility determinants in the EMS

Abstract

This study provides empirical evidence on the determinants of exchange rate credibility under the European Monetary System (EMS). To that end, it considers both economic variables and political factors using data of eight currencies participating in the Exchange Rate Mechanism, covering the complete EMS history (1979 to 1998). The results suggest that the level of international reserves, the real interest rate and right-wing governments would have positively affected the credibility of a given central parity, while the unemployment rate and the inflation rate would have negatively influenced such credibility.

Acknowledgements

The authors thank José Viñals (Bank of Spain) who gave us access to the data on exchange rates and interest rates used in this paper. Financial support from Ministerio de Educación y Ciencia (Project SEJ-2005 09094/ECON) is also gratefully acknowledged. The views expressed here are those of the authors and not necessarily those of the institutions with which they are affiliated.

Notes

¹ The exception being Alogoskoufis et al. (1992) who present a model of exchange-rate policy for the UK, and Drazen (2000) who explains contagion in the exchange rate crises based on political factors.