Appendix: Data Sources and Definitions
Exchange rates: monthly averages of daily quotes; Source: IMF, International Financial Statistics.
Austria: — 3-month term: Termingeld, 3 month offered rate, monthly average of daily quotes, available on a monthly basis since January 1987, Source: Mitteilungen des Direktoriums der Oestereichischen Nationalbank, table 2-12; VIBOR (Vienna Interbank Offered Rate), from June 1, 1989 onward, monthly average of daily quotes, Source: Oesterreichische Nationalbank, Statistisches Monatsheft, table 5.2. long term: government bond yield, all paper outstanding, including bonds benefitting from tax privileges; Source: IMF: IFS.
Belgium: —3 month term: rate on three months Treasury certificates; Source: OECD Main Economic Indicators. — long term: weighted average yield to maturity of all 5 to 8 percent bonds issued after December 1962 with more than 5 years to maturity; Source: IMF: IFS. - - 5 to 6 year bond: 0L0 23/ # 245 (1990-96), weekly data; Source: Datastream. — 10 year bonds: 0L0 # 239 (1989-99) and 247 (1990-2000), weekly data; Source: Datastream.
Denmark: —3 month term: inter-bank interest rate, end-of-period; Source: Danmarks Nationalbank Monetary Review. — long term: effective interest rate on 10-year government bonds, end-of-period; Source: Danmarks Nationalbank Monetary Review.
France: — 3 month term: PIBOR (Paris Interbank Offered Rate); Source: Banque de France, Bulletin Trimestriel, table 35. — long term: yield on long term government bonds (TME); Source: Banque de France, Bulletin Trimestriel, table 38.
Germany: —3 month term: average of daily quotations reported by banks for three-monthly interbank deposit rates; Source: IMF: IFS. — n year term (n - 3 1/2, 5 or 10 depending on the case under consideration): estimated yield of n year maturity bonds, end-of-period; Source: Statistical Supplements to the Monthly Reports of the Deutsche Bundesbank, Series 2, table 8d.
Ireland: —3 month term: average interbank rate; Source: Central Bank of Ireland Quarterly Bulletin, table B2. —5 year term: representative yield on government securities with 5 years to maturity (secondary market yields since February 1989, estimation before); Source: Central Bank of Ireland Quarterly Bulletin, table B2.
Italy: —3 month term: three month interbank rate; Source: IMF: IFS. —long term: secondary market yield on fixed coupon government bonds, with an average maturity of about 3 1/2 years; Source: IMF: Current Economic Indicators, table 12.
Netherlands: — 3 month term: AIBOR (Amsterdam Interbank Offered Rate); Source: Nederlandsche Bank, Kwartaalbericht, table 9.2. — long term: weighted average true yield to maturity of the three most recent government bond Issues with an average original life of at least 10.5 years; Source: IMF: IFS.
Fiscal variables are taken from the OECD Economic Outlook or, for the alternative measures, from Chouraqui et alii (1990).
Consumer price series are extracted from the IMF International Financial Statistics.
Buffel, L.: “De modernizering van de financiële markten en de sanering van de openbare financien: het geval België” Bulletin de Documentation du Ministere des Finances November-December 1990
Chouraqui, J.C., R.P. Hagemann and N. Sartor: “Indicators of Fiscal Policy: A Re-examination” OECD, Economics and Statistics Department Working Paper No. 78 April 1990
European Commission: “One Market, One Money: An Evaluation of the Potential. Benefits and Costs of Forming an Economic and Monetary Union” European Economy No. 44 October 1990
Comments from Lars Svensson, William Perraudin, Taraim Bayoumi, Klaus-Walter Riechel, Edward Gardner and Hari Vittas are gratefully acknowledged. Remaining errors and shortcomings, however, are the author’s sole responsibility.
The methodology is borrowed from Svensson (1990), who carries out the exercise for Sweden, which adopted a target zone policy in 1977, pegging the krona to a trade-weighted currency basket, first without posting the width of the band, and since June 1985 with a publicized ± 1.5 percent band.
It may be noted that an expected realignment would increase the deviation of
Ideally, one would want to compare the yields to maturity on liquid, tax-free zero coupon bonds with exactly the same remaining life, and hence the same duration.
At the end of 1989, the central government’s debt in Denmark amounted to about 60 percent of GDP, down from 75 percent around 1984. Admittedly, this remains well below Belgian levels. In Ireland instead, the debt/GNP ratio stood at 130 percent at the end of 1988, while it was peaking at 136 percent in Belgium at the same date.
As a rule, charts are drawn starting at the last devaluation with respect to the deutsche mark, subject to data availability constraints.
The top panel of Chart 9 shows that this statement holds even if one corrects for the fact that the rate on three-month Treasury certificates, used here, is in Belgium traditionally slightly higher than the corresponding interbank rate. It also suggests that the use of the Euro-Belgian franc rate would not alter the finding.
Interpreting the evidence is difficult due to the low frequency (quarterly) of the available series and to the fact that part of the capital movements do not involve any currency switch.
Tax-exempt bonds (OLOs) were only introduced in May 1989. Note that the reduction of the withholding tax on interest income from new assets from 25 percent to 10 percent, effective on March 1, 1990, seems to translate into a downward shift of the IFS rate around that date, as one would expect. But it remains unclear how much the withholding tax matters here, since financial institutions, which hold a large chunk of the stock of bonds, are exempt, nonresidents are refunded and resident nonfinancial corporations see it credited against income tax. In addition, the IFS rate is computed on the basis of the yield of the existing stock of bonds, while the withholding tax cut applies only to new assets. Moreover, Belgian households have been able to circumvent the tax to some extent by investing in Luxembourg-based mutual funds, some of which specialize in Belgian franc bonds. As for maturities, the yield curve appears rather flat between five and ten years, suggesting that averaging yields over different long maturities does not mask any noteworthy phenomena.
The result obtains only if supply is less responsive than demand to these risk parameters. In the case of France, Davanne et al. (1990) claim that supply is more rigid than demand, due to stock inertia, and therefore that some leveling of the term structure has seemingly occurred as monetary policy became increasingly credible.
In this Instance as well, the modernization now under way should progressively lower the bias.
In general, UIP does not hold, see e.g., the recent survey by Froot and Thaler (1990). However, Svensson (op. cit., p. 5) argues that for narrow target zones UIP still constitutes a good approximation.
Note that in this instance we ignore the distinction between the central ERM parity and the limits associated with the band.
This choice may matter somewhat in the short-term case because up to early 1990 the exchange rate of the Belgian franc vis-à-vis the deutsche mark had systematically wandered in the lower regions of the band (i.e., was relatively weak), which suggests that the pure interest differential is a downward biased measure of the credibility gap defined earlier on.
The primary deficit was selected on the grounds that it represents a more appropriate measure of the current stance of fiscal policy than the interest-inclusive deficit and that the interest payments component is to a large extent already reflected in the debt variable.
The presence of some of the key fundamentals among the right-hand side variables implies that the dummy does not capture much of the anterior convergence of economic performance required for the hard currency policy move to be credible.
The use of OLS is clearly second or even third best here, since errors in variables due to the use of proxies (such as current inflation differentials for anticipated inflation) as well as simultaneous equation biases plague the regressions. Instrumental variable estimation might improve the quality of the results.
For Belgium, volatility dropped from 0.0143 to 0.0034 over the sample period, i.e., well below the panel mean.
Indeed, its tentative inclusion empirically supported this conjecture.
Buffel (1990) reports much higher estimates—ranging from 18 to 41 basis points—for the impact of a 1 percent reduction in the budget deficit to GNP ratio on long-term interest rates.
It must be stressed however that: (a) the standard error associated with the coefficient in the long-run equation is larger than customarily tolerated; (b) such a dramatic fall in the debt ratio could not be brought about without a pronounced and sustained drop in the primary budget deficit, implying that the reasoning on partial effects cannot be accepted uncritically; and (c) the above treatment of panel data is no doubt a very crude one.
0L0 stands for obligations linéaires. which constitute appropriate benchmark paper. Indeed, these bonds come without any call features, are issued in large volumes for each line and are free of the withholding tax (précompte).