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Interest linkages between the US, UK and German interest rates: should the UK join the European Monetary Union?

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  • William Bryant
  • Roselyne Joyeux

Abstract

In light of continuing mixed results in the literature, this paper re-examines the German Dominance Hypothesis (GDH) and considers whether the UK should join the Eurozone. For this purpose, short-term interest rate relationships between the UK, Germany, the Eurozone and the USA, for the period January 1982 to June 2007, are studied. The policy implication of a loss of monetary autonomy for the UK in favour of Germany or the European Central Bank (ECB) would give support to the UK joining the EMU as an economic response. From the early 1980s the Bundesbank's responsibility was to use money growth targets to keep average inflation rate down in the long run. This long run objective suggests that an appropriate methodology for testing the GDH is to test whether the German stochastic trend is a driving stochastic trend. In other words we determine whether a permanent shock to the German interest rate has a permanent effect on the UK interest rate. To this end the structural shocks in a VECM are identified by imposing long-run restrictions of the type developed in King et al. (1991). We apply the same techniques to testing whether the UK has suffered a loss of monetary autonomy in favour of the ECB.

Suggested Citation

  • William Bryant & Roselyne Joyeux, 2010. "Interest linkages between the US, UK and German interest rates: should the UK join the European Monetary Union?," International Review of Applied Economics, Taylor & Francis Journals, vol. 24(6), pages 633-647.
  • Handle: RePEc:taf:irapec:v:24:y:2010:i:6:p:633-647
    DOI: 10.1080/02692171.2010.512143
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    References listed on IDEAS

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    1. W. R. M. Perraudin & E. H. Gardner, 1992. "Asymmetry in the ERM; A Case Study of French and German Interest Rates Since Basle-Nyborg," IMF Working Papers 92/96, International Monetary Fund.
    2. Edward H. Gardner & William R. M. Perraudin, 1993. "Asymmetry in the ERM: A Case Study of French and German Interest Rates Before and After German Unification," IMF Staff Papers, Palgrave Macmillan, vol. 40(2), pages 427-450, June.
    3. De Grauwe, Paul, 1989. "The Cost of Disinflation and the European Monetary System," CEPR Discussion Papers 326, C.E.P.R. Discussion Papers.
    4. Henry, Jerome & Jens Weidmann, 1994. "The French-German Interest Rate Differential since German Unification: The Impact of the 1992 and 1993 EMS Crisis," Discussion Paper Serie B 295, University of Bonn, Germany.
    5. De Grauwe, Paul, 1989. "Is the European Monetary System a DM-Zone?," CEPR Discussion Papers 297, C.E.P.R. Discussion Papers.
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    Cited by:

    1. N. K. Kishor & H. A. Marfatia, 2013. "Does federal funds futures rate contain information about the treasury bill rate?," Applied Financial Economics, Taylor & Francis Journals, vol. 23(16), pages 1311-1324, August.

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