DP649 Counter-Inflationary Policy in the Framework of the EMS

Author(s): Michael J Artis
Publication Date: March 1992
Keyword(s): European Monetary System, Inflation, Real Interest Rates
JEL(s): E52, F31, F41
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=649

The conditions of the `new EMS' - an absence of exchange rate realignments and corresponding added credibility - have given rise to concern about the stabilization properties of the System. Nominal interest rate divergence may have been narrowed ahead of inflation divergence. Cross-country real interest rankings would then assume a negative correlation with the corresponding inflation rankings. The paper argues that on theoretical grounds, a perverse correlation between real interest rates and inflation can be predicted for `old EMS' conditions. Empirical evidence supports this prediction while failing to confirm it for the `new EMS'.