The Unstable EMS

Abstract

opened with a bang and closed with a whimper. In January, the European monetary system (EMS) celebrated five years of exchange rate stability: sixty full months without a realignment. The month before, the representatives of European Community (EC) member-states initialed the Treaty on Economic and Monetary Union concluded at Maastricht in the Netherlands. The transition to European monetary union (EMU) appeared to be fully underway. By the end of the year, the European monetary system had enduredindeed, was continuing to experience-the most severe crisis in its fourteen-year history. Two of ten currencies, the Italian lira and the British For help with data, we thank Samuel Bentolila,

Tests for Nonlinearity in EMS Exchange Rates

“…The EMS system has undergone dramatic change from one of frequent realignment to one where realignments are the exception rather than the rule. Many studies identify the beginning of 1987-the date of the last general realignment-as separating the experience of the ERM into two distinct periods (see, e.g., Frankel and Phillips 1992;Eichengreen and Wyplosz 1993). The early history of the ERM stands in stark contrast to the credible target zone model.…”

“…However, in this case the exchange rate is more responsive to changes in fundamentals as the exchange rate approaches a boundary value than it is under a flexible exchange rate regime. Eichengreen and Wyplosz (1993) noted that a high probability of realignment could be destabilizing, the result of which replaces "the target zone honeymoon with a target zone divorce" (p. 120). 13 The distribution for exchange rates under a credible target zone is U-shaped, which suggests that the exchange rate is more likely observed near one of its boundary values.…”

International Financial Flows and Transactions Taxes: Survey and Options

“…It also bears testimony of the profession's predilection for monetary rather than fiscal solutions as proposed, for instance, by Tornell (1988 and, Eichengreen and Wyplosz (1993), Eichengreen, Tobin and Wyplosz (1995), and, to the extent that a preference is detectable, in UNCTAD (1994). It is clear that there is an option between fiscal and monetary policy measures.…”

“…Tobin remains skeptical in this regard: "Increasing exchange risks will help, but I do not think we should expect too much from it" (Tobin (1978), p. 158). Eichengreen and Wyplosz (1993) consider a monetary policy action equivalent to the fiscal proposition of Tobin. The analytics of this "tax" are unclear, however, depending largely on the definition of the tax base and on the interactions of the implicit tax with related monetary policy measures.…”

“…As discussed in the main text, a nonoptimal fixed rate Tobin tax cannot eliminate exchange rate volatility, which takes place "beyond the margin" of the tax, while the tax severely afflicts normal liquidity trading within its reach. Eichengreen and Wyplosz (1993) consider miscellaneous options to stabilize exchange rates between currencies of members of the European Monetary System or, more generally, of the EU. In this context, they also discuss a Tobin tax on foreign exchange transactions.…”