The EMS, the EMU, and the Transition to a Common Currency
AbstractWhen central banks are about to relinquish control over their exchange rate and enter into a currency union, the reptutational costs to devaluation are very low. As with any finite-horizon game, the endpoint affects the earlier expectations of private agents, here causing them to demand higher interest rates and higher wages from countries whose currencies are relatively weak. In looking at the countries within the EMS, we find that Italian long-term interest rates as well as price and wages levels relative to Germany show evidence of growing gaps We also find that the real appreciation of the lira appears to be predominantly due to increases in relative Italian government spending, and not to relatively rapid Italian productivity growth. Taken together, this evidence suggests that convergence within the EMS may have peaked. Furthermore, moving forward the date of currency union may in the short run increase both the growth of the gaps and the need for exchange-rate realignment.
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Bibliographic InfoPaper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3684.
Date of creation: Apr 1991
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Publication status: published as Kenneth A. Froot, Kenneth Rogoff. "The EMS, the EMU, and the Transition to a Common Currency," in Olivier Jean Blanchard and Stanley Fischer, editors, "NBER Macroeconomics Annual 1991, Volume 6" MIT Press (1991)
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- Kenneth A. Froot & Kenneth Rogoff, 1991. "The EMS, the EMU, and the Transition to a Common Currency," NBER Chapters, in: NBER Macroeconomics Annual 1991, Volume 6, pages 269-328 National Bureau of Economic Research, Inc.
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