Monetary and Financial Spillovers: New Historical Evidence from Germany

Using newly identified exogenous variation in German monetary policy from 580 policy meetings between 1974 and 1998, we provide new evidence on the role of the exchange rate regime in monetary spillovers. Germany played a central role in the European Monetary System over these decades. Following a German monetary tightening, European countries pegged to the Deutschmark experienced unchanged nominal exchange rates, higher short-term interest rates and sizable economic contractions. In contrast, floating exchange rate economies in Europe saw a sizable depreciation of their currency vis-á-vis Germany, but limited short-run movements in interest rates, activity or prices. U.S. monetary tightenings had similar effects on both Deutschmark pegs and floats. Our findings are consistent with the predictions of the trilemma.