DP485 Exchange Rate Dynamics and Currency Unification: The Ostmark-DM Rate

Author(s): Michael C Burda, Stefan Gerlach
Publication Date: December 1990
Keyword(s): Deutschmark, Kalman Filtering, Monetary Union, Ostmark
JEL(s): 431
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=485

This paper studies the exchange rate between the East and West German mark in the period before German monetary union. We show that standard exchange rate theory contains strong predictions about the dynamics of the exchange rate under these circumstances, and we use state-space methods to estimate key parameters of the model. A random-walk model gives a good fit to the first half of the data, during which it was unclear that monetary union would occur. In the second half, when union was expected, the Ostmark rate behaves as a weighted average of fundamentals and the expected terminal exchange rate.