n Discussion Paper No. 1530, Research Fellow Paul De Grauwe looks at the problem of how conversion rates will be determined at the start of EMU. Decisions concerning membership of EMU should be taken early in 1998, but conversion rates can not bes set until 1 January 1999. This creates a transition period of uncertainty and may invite strong and destabilizing speculation.

De Grauwe analyses, in the context of a simple exchange rate model, three possible rules for setting the conversion rate to minimize these problems. He looks at an announcement that the final rate will be based on weighted averages of market rates over a given period (the Lamfalussy rule); an announcement of fixed conversion rates; and an announcement that the conversion rates will be the market rates just prior to the start of EMU. De Grauwe compares the first two rules, and finds that the Lamfalussy rule causes more problems than it solves. An announcement of fixed conversion rates is potentially more effective, but requires a ‘commitment technology’ to be set in place to ensure its credibility. If this is not done, it will be necessary to allow a sufficient amount of flexibility in exchange rates prior to the start of EMU to absorb speculative shocks.

How to Fix Conversion Rates at the Start of the EMU
Paul de Grauwe