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Pegs, Baskets, and the Importance of Policy Credibility: Lessons of the 1992-93 ERM Crisis

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  • Volz, Ulrich

Abstract

This paper argues that, in contrast to the popular bipolar view on exchange rate choices, intermediate regimes in general and regional exchange rate systems such as the European Monetary System (EMS) in particular should not be ruled out per se even in today?s world of highly mobile capital. The paper highlights that the 1992/93 crisis of the EMS? Exchange Rate Mechanism was a crisis of an exchange rate system and not just the collapse of unilateral pegs pursued by individual countries. Based on an assessment of credibility of the EMS before and during the crisis, the paper discusses distinct features that add to the credibility of regional exchange rate systems. It reasons that a system that is built around well-defined rules, and which is managed very carefully and co-operatively according to those rules, could be both credible and sustainable even in the 21st century.

Suggested Citation

  • Volz, Ulrich, 2005. "Pegs, Baskets, and the Importance of Policy Credibility: Lessons of the 1992-93 ERM Crisis," HWWA Discussion Papers 323, Hamburg Institute of International Economics (HWWA).
  • Handle: RePEc:zbw:hwwadp:26238
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    References listed on IDEAS

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    1. Barry Eichengreen, 1998. "Does Mercosur Need a Single Currency," NBER Working Papers 6821, National Bureau of Economic Research, Inc.
    2. Lars E. O. Svensson, 1991. "The Simplest Test of Target Zone Credibility," IMF Staff Papers, Palgrave Macmillan, vol. 38(3), pages 655-665, September.
    3. Obstfeld, Maurice, 1996. "Models of currency crises with self-fulfilling features," European Economic Review, Elsevier, vol. 40(3-5), pages 1037-1047, April.
    4. Krugman, Paul, 1979. "A Model of Balance-of-Payments Crises," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 11(3), pages 311-325, August.
    5. Paul R. Krugman, 1991. "Target Zones and Exchange Rate Dynamics," The Quarterly Journal of Economics, Oxford University Press, vol. 106(3), pages 669-682.
    6. Campa, Jose Manuel & Chang, P H Kevin, 1996. "Arbitrage-Based Tests of Target-Zone Credibility: Evidence from ERM Cross-Rate Options," American Economic Review, American Economic Association, vol. 86(4), pages 726-740, September.
    7. Carsten Hefeker & Andreas Nabor, 2005. "China's role in East-Asian monetary integration," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 10(2), pages 157-166.
    8. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-491, June.
    9. Barry Eichengreen & Charles Wyplosz, 1993. "The Unstable EMS," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 24(1), pages 51-144.
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    More about this item

    Keywords

    exchange rate regimes; regional monetary systems; EMS crisis; policy credibility;

    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • F02 - International Economics - - General - - - International Economic Order and Integration
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
    • F42 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Policy Coordination and Transmission

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