Exchange Rate and Interest Rate Distribution and Volatility under the Portuguese Target Zone
AbstractThe aim of this study is to analyse the exchange rate and interest rate distribution and volatility under the participation of the Portuguese economy in the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) based on some of the main predictions of the target zone literature. Portugal adopted this exchange rate target zone from April 6 1992 until December 31 1998. During this period, the exchange rate distribution reveals that the majority of the observations lie close to the central parity, thus rejecting one of the key predictions of the Paul Krugman (1991) model. The analysis of the data also shows that exchange rate volatility tended to increase as the exchange rate approached the edges of the band, contrary to the predictions of the basic model. Interest rate differential volatility, on the other hand, seemed to behave in line with theoretical predictions. This suggests an increase in the credibility of monetary policy, allowing us to conclude that the adoption of a target zone has contributed decisively to the creation of the macroeconomic stability conditions necessary for the participation in the European Monetary Union (EMU). The Portuguese integration process should therefore be considered as an example to be followed by other small open economies in transition to the euro area.
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Bibliographic InfoArticle provided by Savez ekonomista Vojvodine, Novi Sad, Serbia in its journal Panoeconomicus.
Volume (Year): 57 (2010)
Issue (Month): 3 (September)
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Web page: http://www.panoeconomicus.rs/
Exchange rate stability; EMS; Volatility and target zones;
Find related papers by JEL classification:
- C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
- C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
- F31 - International Economics - - International Finance - - - Foreign Exchange
- F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
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