Simple credibility tests of the ERM bands for the pound sterling and the Italian lira

Elias Belessakos and Michael Papaioannou

Open Economies Review, 1996, vol. 7, issue 3, 219-236

Abstract: This article presents evidence that the European Monetary System (EMS) bands for the Italian lira and the pound sterling were not credible for most of the period 1990–1992, and especially during the week prior to their withdrawal from the EMS system. Using a simple test, developed by Svensson, domestic interest rates for both Italy and the United Kingdom have been found to be mostly outside the rate-of-return bands implied by the official arrangements of the EMS target zone system. Furthermore, comparing implied forward rates for various maturities with the official EMS bands of both currencies, we again found that the followed monetary policies in both countries were not in general consistent with those needed to maintain an orderly functioning of the (EMS) system. The Svensson test can further be used as an indicator of potential speculative attacks on an EMS currency, and, in turn, as a signal of an emerging need to adjust the corresponding country's monetary policy. Copyright Kluwer Academic Publishers 1996

Keywords: F31; F33 (search for similar items in EconPapers)
Date: 1996
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DOI: 10.1007/BF01886822

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