Summary of WP/92/87
“Implementation of Monetary Policy in EMS Countries Participating in the Exchange Rate Mechanism” by Michel Galy
Efforts to stabilize exchange rates in the framework of the European Monetary System (EMS) led to gradual monetary integration and interest rate convergence among the core EMS countries during 1979-91. It has been argued that the burden imposed by convergence on domestic policies was not equally shared among EMS members and that the German central bank retained a leadership role during this period.
This paper uses various Granger-causality tests and estimation of central banks’ reaction functions to determine possible changes in regime and their rationale. The results support the thesis of German leadership but also point to an increased interdependence between French and German monetary policies after 1981-82, whereas the Italian and Spanish central banks appear to have retained more significant monetary autonomy. Changes in regime appear to be concentrated in the first years of the exchange rate mechanism (ERM) and are related to technical changes in the implementation of monetary policy and to the introduction of adjustment programs to strengthen the credibility of the exchange rate commitment, generally following a major realignment. The total removal of capital controls in 1990-91 has undoubtedly further reduced monetary autonomy among ERM participants, including Germany, thus requiring a rapid implementation of the concerted approach proposed in the Maastricht Agreement. However, the consecutive possible changes in ERM central banks’ behavior are too recent to be identified by the tests presented in this paper.