Previous work on the ERM has examined the dynamics of monetary variables and aggregates to assess the influence of German monetary policy on the rest of Europe, but their use of monthly or quarterly data has precluded serious investigation of structural breaks. In Discussion Paper No. 753, Edward Gardner and Research Fellow William Perraudin use daily data on long- and short-term interest rates to examine the evolution of the relationships among French, German and US interest rates from the Basel-Nyborg agreement of September 1987 up to August 1992, to see whether German unification significantly altered the extent of German leadership within the ERM. They first estimate models for short-term interest rates that can identify interactions between them. Then they calculate long-run multipliers for the impulse effects of shocks across markets for sub-periods before and after German unification, for both Euromarket and national interest rates.

Gardner and Perraudin find that German leadership largely disappeared in the year following unification, and there was a gradual return to the status quo ante after that. There was a consistent pattern of a marked asymmetry before unification, with shocks to German interest rates far more important for French rates than vice versa, but there was a virtual reversal in 1990, with French rates seeming almost to take over the leadership role. They also use structural break tests to assess the proposition that German unification affected market perceptions and policy reactions around the beginning of 1990, without specifying the precise date in advance, and find that the break occurred within a very few weeks of the start of 1990. They conclude that German monetary policy altered significantly in reaction to the early stages of German unification, but less obviously than fiscal policy, whose earlier tightening might have reduced the need for the stringent policies that the monetary authorities have recently felt constrained to pursue.


Asymmetry in the ERM: A Case Study of French and German Interest Rates Since Basel-Nyborg
Edward H Gardner and William R M Perraudin

Discussion Paper No. 753, January 1993 (AM)