ERM and EMU — Survival, Costs and Prospects

Evaluating the EMS and EMU Using Stochastic Simulations: Some Issues

“…We therefore agree with Minford and Rastogi (1990) that these risk premium shocks are unreasonably large, but disagree that option (c) is the correct method. Getting a reasonable empirical.estimate was the rationale for the random walk assumption of (b); in fact in FGM (1989) time series model were identified, and not surprisingly (given what we know, e.g., from Méese and Rogoff, 1983), a unit autoregressive (i.e., AR(1)) coefficient, or something near it, describes the exchange rate data well.…”

“…1/ Minford and Rastogi (1990) for instance state: "A systematic comparison with our results is difficult because the Multimod study takes interest rate reaction functions as given, whereas we assume money supplies as given under 'fixed money ' ... " (p. 59) 2/ The parameters for the nominal income rule used in this paper were made as close to the EC Commission values as possible. However, with real income and inflation targets their parameterization did not always converge and we therefore used somewhat smaller reaction coefficients.…”

“…The EC Commission chooses option (d), after pointing out some of the pitfalls associated with the other options. Minford and Rastogi (1990) also strongly reject options (a) and (b), the first as wrong and the second because it is inconsistent with MULTIMOD, but they criticize the Commission for choosing (d) on the grounds that it is also inconsistent with MULTIMOD. Furthermore it gives shocks which Minford and Rastogi consider "strain credulity" because they are so large--standard deviations of 5 to 11 percent.…”

“…EMS (in particular, realignments); (2) how monetary policy would be determined in EMU;and (3) what structural changes would result from EMU-in particular, how to estimate the effects of reductions in the risk premia in interest rates. Some of these methodological issues have already been raised by the EC Commission (1990), Minford and Rastogi (1990), and Emerson and Italianer (1990), but it may be useful for participants in the debate to get an outsider's view. Since we are able to redo the simulations on MULTIMOD, we may be able to discover how much of the difference in results is due to different assumptions or to different models.…”

Choosing the Regime: Macroeconomic Effects of UK Entry into EMU

“…In this article we extend previous work, widening the scope of the shocks we analyse and using a more complete and coherent model. Minford et al (1992), for instance, discuss the Exchange Rate Mechanism (ERM), and floating exchange rates using a large macro model with some forward-looking elements, and conclude that floating rates are better than fixed mechanisms. However, it is important to note that they assume that the exchange rate as described by their equation is not subject to random shocks.…”