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Political and institutional factors in regime change in the ERM: An application of duration analysis

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  • Simón Sosvilla-Rivero

    (FEDEA and Universidad Complutense de Madrid)

  • Francisco Pérez-Bermejo

    (KPMG-Spain)

Abstract

This paper analyses the functioning of the European Exchange Rate Mechanism (ERM). To that end, we apply duration models to estimate an augmented target-zone model, explicitly incorporating political and institutional factors into the explanation of European exchange rate policies. The estimations are based on quarterly data of eight currencies participating in the ERM, covering the complete history of the European Monetary System. Our results suggest that both economic and political factors are important determinants of the ERM currency policies. Concerning economic factors, the money supply, the real exchange rate, the interest in Germany and the central parity deviation would have negatively affected the duration of a given central parity, while credibility and the price level in Germany would have positively influenced such duration. Regarding political variables, elections, central bank independence and left-wing administrations would have increased the probability of maintaining the current regime, while unstable governments would have been associated with more frequent regime changes. Moreover, we show how the political augmented model outperforms, both in terms of explanatory power and goodness of fit, the model which just incorporates pure economic determinants.

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Bibliographic Info

Paper provided by Asociación Española de Economía y Finanzas Internacionales in its series Working Papers with number 07-05.

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Length: 41 pages
Date of creation: Oct 2007
Date of revision:
Handle: RePEc:aee:wpaper:0705

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Keywords: Duration analysis; political variables; exchange rates; European Monetary System;

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  16. Paul R. Krugman, 1988. "Target Zones and Exchange Rate Dynamics," NBER Working Papers 2481, National Bureau of Economic Research, Inc.
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