European Monetary Union, the Term Structure, and the Lucas Critique

Peter Bergeijk and Jan Marc Berk

Kyklos, 2001, vol. 54, issue 4, 547-556

Abstract: In order to evaluate the empirical relevance of the Lucas Critique, we investigate whether the term structure (the relation of the long interest rate to the short interest rate) showed structural change as the deadline for the euro came closer. Our empirical analysis of the term structures (yield curves) in 12 OECD countries uncovers that econometrically estimated behavioural equations for most EMU countries were stable even in the light of the creation of the euro. This finding would seem to defy the Lucas Critique. However, the significant structural instability found for the euro area's core country, Germany, suggests that the Lucas Critique is relevant in the analysis of the impact of the creation (and future extensions) of EMU. Preliminary versions of this paper were presented at the ECB workshop on yield curve modelling, Frankfurt (1999) and the Finance Seminar at the University of Zurich (2000). Comments by participants of both workshops and by two anonymous referees are gratefully acknowledged.

Date: 2001
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