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Explaining devaluation expectations in the EMS

  • Ulf Söderström

    (Stockholm School of Economics, Sweden)

  • Alexis Stenfors

    (Midland Bank plc, Stockholm Branch, Treasury and Capital Markets, Sweden)

This paper is an attempt to explain devaluation expectations in the ERM with macroeconomic fundamentals. Two different measures of devaluation expectations are used; expectations estimated using the drift-adjustment method of Bertola and Svensson (1993), and the directly observable interest rate differential. The interest rate differential seems more closely connected to macroeconomic fundamentals than the estimates stemming from the drift-adjustment method. For the ERM as a whole, an expanded monetary model of exchange rate determination explains a considerable part ofthe devaluation expectations, whereas for individual countries additional variables are important, but the relationships are ambiguous and country-specific.

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Article provided by Finnish Economic Association in its journal Finnish Economic Papers.

Volume (Year): 8 (1995)
Issue (Month): 2 (Autumn)
Pages: 63-81

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Handle: RePEc:fep:journl:v:8:y:1995:i:2:p:63-81
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  1. Svensson, Lars E O, 1991. "The Simplest Test of Target Zone Credibility," CEPR Discussion Papers 493, C.E.P.R. Discussion Papers.
  2. Zhaohui Chen & Alberto Giovannini, 1992. "Estimating Expected Exchange Rates Under Target Zones," NBER Working Papers 3955, National Bureau of Economic Research, Inc.
  3. Hansen, Lars Peter & Hodrick, Robert J, 1980. "Forward Exchange Rates as Optimal Predictors of Future Spot Rates: An Econometric Analysis," Journal of Political Economy, University of Chicago Press, vol. 88(5), pages 829-53, October.
  4. Krugman, Paul R, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 669-82, August.
  5. Vincent Koen, 1991. "Testing the Credibility of the Belgian Hard Currency Policy," IMF Working Papers 91/79, International Monetary Fund.
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