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The Behaviour of the Dollar and Exchange Rates in Europe: Empirical Evidence and Possible Explanations

Author

Listed:
  • Paolo del Giovane

    (Banca d'Italia)

  • Alberto Franco Pozzolo

    (Banca d'Italia)

Abstract

The analysis of the day-by-day evolution of currency markets often emphasises the relationship between the behaviour of the US dollar and that of the exchange rates between the other major currencies, in particular the tendency of EMS currencies to appreciate vis-�-vis the DM in periods of dollar strength. In this paper we systematically analyse this relationship. In particular, we examine the extent to which it has changed in the last ten years, a span of time that included a period without realignments in the EMS, the crisis of the System, the suspension of the lira’s participation in the ERM and the withdrawal of the pound, the “widened” band for the other currencies, and the re-entry of the lira. We also suggest a possible explanation for this relationship and find supporting empirical evidence for it: we show that the reactions of each bilateral exchange rate to shocks to the value of the dollar are related to the different orientation of monetary and exchange-rate policies in the various European countries, and that these differences are consistent with the potential effects of variations in the exchange rates vis-�-vis the dollar and the DM on each country’s rate of inflation.

Suggested Citation

  • Paolo del Giovane & Alberto Franco Pozzolo, 1998. "The Behaviour of the Dollar and Exchange Rates in Europe: Empirical Evidence and Possible Explanations," Temi di discussione (Economic working papers) 328, Bank of Italy, Economic Research and International Relations Area.
  • Handle: RePEc:bdi:wptemi:td_328_98
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    File URL: http://www.bancaditalia.it/pubblicazioni/temi-discussione/1998/1998-0328/tema_328_98.pdf
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    References listed on IDEAS

    as
    1. Lucas, Robert Jr., 1982. "Interest rates and currency prices in a two-country world," Journal of Monetary Economics, Elsevier, vol. 10(3), pages 335-359.
    2. McCallum, Bennett T., 1994. "A reconsideration of the uncovered interest parity relationship," Journal of Monetary Economics, Elsevier, vol. 33(1), pages 105-132, February.
    3. Pesaran, M. H. & Shin, Y. & Smith, R. J., 1996. "Testing for the 'Existence of a Long-run Relationship'," Cambridge Working Papers in Economics 9622, Faculty of Economics, University of Cambridge.
    4. repec:crs:wpaper:9645 is not listed on IDEAS
    5. Haldane, A G & Hall, S G, 1991. "Sterling's Relationship with the Dollar and the Deutschemark: 1976-89," Economic Journal, Royal Economic Society, vol. 101(406), pages 436-443, May.
    6. Frankel, Jeffrey A., 1986. "The implications of mean-variance optimization for four questions in international macroeconomics," Journal of International Money and Finance, Elsevier, vol. 5(1, Supple), pages 53-75, March.
    7. Mayshar, Joram, 1983. "On Divergence of Opinion and Imperfections in Capital Markets," American Economic Review, American Economic Association, vol. 73(1), pages 114-128, March.
    8. Rudebusch, Glenn D., 1995. "Federal Reserve interest rate targeting, rational expectations, and the term structure," Journal of Monetary Economics, Elsevier, vol. 35(2), pages 245-274, April.
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    Cited by:

    1. Gabriele Galati, 2001. "The Dollar-Mark axis," Review of World Economics (Weltwirtschaftliches Archiv), Springer;Institut für Weltwirtschaft (Kiel Institute for the World Economy), vol. 137(1), pages 36-57, March.

    More about this item

    Keywords

    exchange rate; Europe; fundamentals; forecast;

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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