Working Paper: CEPR ID: DP597
Authors: Luisa Lambertini; Marcus Miller; Alan Sutherland
Abstract: In the first decade of its existence the EMS passed through three phases of realignments: full accommodation, partial accommodation and zero accommodation of inflation differentials. To what extent, however, does the new freedom of capital movements within the EC rule out such gradual convergence with realignments for new members? This paper uses a model with forward-looking behaviour in labour and financial markets to analyse this question. A rule which partially accommodates inflation differentials is shown to be consistent with inflation convergence and perfect capital mobility, provided that the timing of realignments is stochastic and the rule is fully credible.
Keywords: exchange rate; realignments; EMU; EMS; inflation convergence
JEL Codes: F31; F33; F36
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| realignment rule which preserves competitiveness (D72) | continuous inflation and depreciation (E31) |
| anticipation of realignments (D84) | wage contracts (J41) |
| wage contracts (J41) | inflationary pressures (E31) |
| realignment rule for partial accommodation of inflation (E31) | inflation convergence (E31) |
| degree of accommodation (I24) | long-term price levels (E30) |
| perfect capital mobility and rational expectations (D84) | unpredictability of timing of realignments (D84) |