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Edward H. Gardner is an Economist in the European I Department and holds a Ph.D. from the Massachusetts Institute of Technology. William R.M. Perraudin is a Fellow of Gonville and Caius College, Cambridge University, and of the Centre for Economic Policy Research and holds a Ph.D. from Harvard University. The paper was written, in part. while Mr. Perraudin was a Visiting Scholar in the European I Department. The authors thank Leonardo Bartolini and Michael Deppler for helpful comments.
The range of permitted fluctuation above and below the central rates over our sample period was 6 percent for the British pound and the Spanish peseta and 2.25 percent for the other participating currencies. The Spanish peseta only entered into the ERM in June 1989.
The first impulse to German unification came from the mass emigration from the German Democratic Republic (GDR) to West Germany that followed the opening of the border between Hungary and Austria in September 1989, With the opening of the border between the two Germanies in November of the same year, the volume of people moving from the GDR rose to massive proportions, bringing into question the viability of the GDR as a separate nation. A currency union between the two Germanies was proposed by Chancellor Helmut Kohl in February 1990. and the final terms of unification were negotiated in April and May 1990. For a further discussion of these events and their economic effects, see Lipschitz and McDonald (1990),
The Basle–Nyborg agreement caused some concern in Germany that the obligation to finance intramarginal interventions could lead to the creation of excessive liquidity by the Bundesbank, thereby undermining the anti–inflationary stance of German monetary policy. Several factors reduced this risk, however. First, intramarginal intervention using a partner’s currency still requires the prior approval of the central bank issuing the intervention currency, and, second, the amounts involved are small relative to the total monetary base. Moreover. with most central banks using interest rates as intermediate targets, the monetary effects of intervention tend to be automatically sterilized. Following the ERM crisis of September 1992, Germany. for the first time. intervened intramarginally in support of another ERM currency, the French franc. This is more likely to reflect the gravity of the strains within the ERM at the time than a change in Germany’s role in the ERM.
Of course, German unification occurred at the same time as Eastern Europe as a whole began its process of reform. Flows of net investment to Eastern Europe, except to the former East Germany. have remained fairly negligible, however, and it is hard to believe that the more general reform process has significantly affected monetary events in the Western economies.
Interbank rates have the advantage that their tax–exempt status insulates them from the effect of changes in taxation.
For example, regular movements in rates associated with the cycles of bank reserve accounting introduce negative autocorrelation that has nothing to do with the dynamics of genuine shifts in monetary policy, obscuring actual policy changes.
One might, nevertheless, argue that we should include lagged exchange rate changes in our regressions. Our initial estimations did include such lags, but they had no significant explanatory power so we felt justified in omitting them.
Assumptions 1 and 2 would be sufficient to identify all but one of the parameters. For discussions of identification in linear models with covariance restrictions, see Hausman and Taylor (1983) and Hausman, Newey, and Taylor (1987).
Onshore rate changes exhibit kurtosis ranging up to almost 200, compared with the kurtosis of any normal random variable of 3.
See Newey and West (1987).
Note that we ignore possible feedback effects through changes in long–term interest rates. According to Artus and others (1991), French and German longterm rates are only weakly affected by movements in short–term rates.
The one exception is for U.S. rate effects on French and German rates.