Working Paper: CEPR ID: DP96
Authors: Jacques Melitz; Philippe Michel
Abstract: The European Monetary System (EMS) has proven to work remarkably well thus far, despite three major realignments. We make an attempt to explain the dynamic stability of the system. This attempt gives a central place to movements in desired transactions balances, or `leads and lags', as they are known. We assume the absence of pure speculation, although we examine this assumed absence after completing our main argument. Two important features of the EMS in our model, apart from leads and lags, are uncertainty of realignment dates and coordinated adjustments in interest rates by the central banks of the member governments.
Keywords: European Monetary System; Stability; Transactions Balances; Leads and Lags; Currency Realignment Dates; Coordinated Policy
JEL Codes: 430
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| transaction balances (F38) | stability of the EMS (C62) |
| interest rates (E43) | stability of reserves (E63) |
| leads and lags in foreign trade (F14) | desired transaction balances (F33) |
| realignment (D79) | capital flows into France (F21) |
| capital flows into France (F21) | current account surplus (F32) |
| current account surplus (F32) | adjustments in interest rates by central banks (E52) |
| uncertainty regarding realignment dates (D84) | dynamic stability (C62) |
| threat of capital controls (F38) | dynamic stability (C62) |