Credibility and Disinflation in the European Monetary System
Analysis of interest differentials in the European Monetary System has suggested a widespread lack or credibility of the Exchange Rate Mechanism (ERM) in the sense that in most countries the implicit expected rate of devaluation was significant and not far short of inflation differentials vis-a-vis the deutschmark. The authors present and test a model in which prices reflect expectations of exchange rate behavior. The results provide mixed evidence that price-setting in countries that participated in the ERM was influenced by the exchange rate discipline. Copyright 1997 by Royal Economic Society.
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