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The Italian Lira in the Narrow Erm Band: The Challenge of Credibility

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  • Mr. Lazaros E. Molho

Abstract

Under free capital mobility, a high-inflation country pursuing a nonaccommodating exchange rate policy will have higher real interest rates than its lower-inflation trading partners as long as that policy is not credible. If the policy gains credibility prior to inflation convergence, the sign of the real interest rate differential may be reversed. Developments in interest rate differentials and capital and reserve flows suggest that Italy’s nonaccommodating exchange rate policy has become significantly more credible in 1989-90. As improved credibility further limits their monetary autonomy, the Italian authorities will have to rely more on fiscal and incomes policies to promote disinflation.

Suggested Citation

  • Mr. Lazaros E. Molho, 1991. "The Italian Lira in the Narrow Erm Band: The Challenge of Credibility," IMF Working Papers 1991/019, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:1991/019
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    Cited by:

    1. Elias Belessakos & Michael Papaioannou, 1996. "Simple credibility tests of the ERM bands for the pound sterling and the Italian lira," Open Economies Review, Springer, vol. 7(3), pages 219-236, July.

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