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This study examines the interdependence and asymmetries in the relationships between the economic policy uncertainty and the selected financial stability variables in Europe. Specifically, the impact of uncertainty on inflation, equity returns, the euro in US dollar exchange rate and interest rates is analyzed. The results show a significant negative impact of shocks in economic policy uncertainty on equity returns in Europe during the examined January 1987 – January 2023 period. Uncertainty shocks affect inflation asymmetrically at different time intervals. Asymmetric responses of interest rates and the exchange rate to uncertainty shocks are also found. The results suggest that economic policies in Europe should encompass efforts to mitigate economic uncertainty. [ABSTRACT FROM AUTHOR]

The focus of this research is the identification of the fear of floating (FOF) problem as a vulnerable ground for employing the exchange rate (ER) as a shock absorber with consequent limitations for expenditure-switching external adjustment mechanism. This research aims to fill the literature gap stressing the connection between FOF and the functioning of expenditure-switching external adjustment mechanism, highlighting the nexus from the viewpoint of emerging European vs. Latin American floaters, as well as from individual emerging European floaters (the Czech Republic, Hungary, Poland, Romania) in the period 2000Q1-2017Q2 with standard and panel VAR analysis. FOF is identified as a stronger reaction of foreign exchange reserves and interest rate to nominal ER shocks, as well as higher variations of real ER explained with price shocks compared to nominal ER shocks. As a confirmation, in countries with expressed FOF current account shock is more transmitted to economic activities (expenditure-reducing external adjustment) rather than nominal ER changes (expenditure-switching mechanism). The results confirm the vulnerable position of European emerging floaters compared to Latin American floaters, bearing in mind the stronger FOF coinciding with the higher currency mismatch. Within the sample of European emerging floaters the most vulnerable position concerning the nexus was detected for Romania, while the most favorable position was found in the case of Poland. [ABSTRACT FROM AUTHOR]

The article focuses on the creation of a system for monetary stability in Europe. The article also discusses the contribution of the European Monetary System (EMS) to the reduction of the exchange rate volatility and the importance of capital controls for the increased volatility of interest rate differentials. It is explained in the article that the goal behind the foundation of the European Monetary System (EMS) in March 1979 was the creation of a system of monetary stability in Europe. The adoption of the EMS is attributed to the reduction of the intra-EMS nominal and real (bilateral and effective) exchange rate volatility relative to the pre-EMS period.

This paper investigates the long-run and short-run relationship between deposit euroization in twelve European post-transition economies and two determinants of deposit euroization that are under the influence of monetary policy: the exchange rate and the interest rate differential. The link between deposit euroization, exchange rates and interest rate differentials is investigated using Johansen cointegration and error correction models for each country separately. The results suggest that changes in both monetary drivers have significant effects on deposit euroization and are therefore important for explaining and fighting deposit euroization. Differences between exchange rate regimes, fixed and managed vs. floating, seem to matter for deposit euroization. [ABSTRACT FROM AUTHOR]

During the recent credit crisis, European currencies tended to depreciate when the domestic country had relatively high long-term interest rates overshooting traditional uncovered interest rate parity. Absolute interest rate differentials, not innovations to the interest rate differential, drove the depreciation. The degree of the crisis, as measured by the TED spread, amplified this effect. Current account deficits, high inflation, and external debt held by governments or by banks only indirectly drove depreciation by creating higher domestic interest rates. In addition to the interest rate effect, Hungary saw currency depreciation relative to other East European currencies as the TED spread widened. [ABSTRACT FROM AUTHOR]

While many transition economies – particularly those that hope to join the Euro – have seen their economies converge to Europe’s, this process is by no means complete. Considerable macroeconomic volatility persists. This study examines the variability of the short-term nominal interest rates of ten transition economies, finding that eight of them exhibit time-varying volatility that can be modeled as a GARCH or Exponential GARCH process. Incorporating various measures of external volatility into the models, we find that those economies with fixed or managed exchange rates tend to experience more volatility spillovers, particularly from the Eurozone, regardless of the degree of transition. Only Estonia has a fixed exchange rate and remains free of international contagion. [ABSTRACT FROM AUTHOR]

A panel data set for six countries (Czech Republic, Hungary, Poland, Romania, Slovakia and Slovenia) is used to estimate money demand with panel cointegration methods over the recent disinflation period. The basic money demand model is able to convincingly explain the long-run dynamics of M2 in the selected countries. However, money demand is found to have been significantly determined by the euro area interest rates and the exchange rate against the euro, which indicates possible instability of money demand functions in the Central and Eastern European countries. Therefore, direct inflation targeting is an appropriate monetary regime before the eventual adoption of the euro. [ABSTRACT FROM AUTHOR]

The appetite for fiscal discipline has been steadily declining among most industrial countries. In the past, fiscal profligacy would have been punished by markets with higher interest rates and, in some cases, also exchange rate depreciation. However, in post-EMU Europe, exchange rate markets no longer discipline the fiscal behaviour of national governments. Perhaps more crucially, even the interest rate punishment to fiscal indiscipline is highly uncertain, with academic opinions being quite divided on this issue. This paper takes a close look at the link between fiscal policy and interest rates in the European context. The key finding is that an expansionary fiscal policy in one EMU member will have an effect both on its spreads and on the overall level of interest rates for the currency union as a whole, with the second effect, however, being quantitatively much more significant. This suggests that there are indeed substantial spillovers, through the interest rate channel, among fiscal policies of member countries. To limit countries' incentive to run expansionary fiscal policies, a set of rules, like those embedded in the Stability and Growth Pact, is then needed. Some (weak) evidence is also found that after EMU, interest rate spillovers seem to be more significant for high debt countries with unsustainable fiscal policies, reflecting perhaps market concerns about a possible sovereign bail out or the impact of financial distress. There may be a case then for imposing tighter rules on high debt countries. [ABSTRACT FROM AUTHOR]

This article examines the new consensus that fiscal policy should have no macroeconomic role in 'flexible inflation targeting' regimes. There is little basis for this presumption. Fiscal policy remains important in setting the policy mix and in managing shocks and imbalances. The credibility of an inflation-targeting regime should be enhanced rather than reduced if fiscal policy plays its proper role. It is true, nevertheless, that the costs of focusing fiscal policy narrowly on public-sector concerns may not be very great, most of the time. However, when interest rates cannot be used, the role of fiscal policy must be different. With interest rates at their lower bound of zero, there is no plausible alternative. For asymmetric shocks and adjustments in EMU, fiscal policy needs, ideally, to substitute for the interest-rate policy reaction function of the consensus, but the difficulties are very great. We suggest a policy focus on real exchange rates as a way of resolving some of the dilemmas. There is a serious danger that orthodox views about fiscal policy, drawn from the consensus, will be inappropriately applied, especially in Europe. [ABSTRACT FROM AUTHOR]

This article looks at the activities of the European Central Bank (ECB) in 2004. In prospect the ECB must have thought that 2004 was at last going to be the year when inflation fell back below two per cent despite the historically low level of interest rates. But no, there were just enough unexpected shocks particularly from rapidly rising oil prices in the second half of the year to keep it up above that figure. The Governing Council did not change the setting of monetary policy during the year, in the sense of altering their interest rate settings but a glance at the exchange rate movement during the year shows that the effective rate tightened by about six percentage points. While opinions vary about the equivalence of the impact of the exchange rate and the ECB interest rate on future inflation and output this is equivalent to a tightening of at least 50 basis points.

Empirical work on uncertainty and investment generally focuses on one country or one indicator of uncertainty. We extend the literature by assessing the impact of a comprehensive range of potential sources of uncertainty on aggregate business investment across the G7 using Pooled Mean Group Estimation (PMGE) and GARCH methods to model uncertainty. A significant negative long-run effect from exchange rate volatility is found for the G7 and in poolable subgroups including all four larger EU countries. Volatility of long-term interest rates has additionally influenced investment in recent years. For most estimates, a one standard deviation rise in conditional volatility leads to a 2-4 per cent fall in investment although some samples give greater declines. The results suggest inter alia that EMU is beneficial to aggregate investment, JEL no. E22, F31 [ABSTRACT FROM AUTHOR]

This paper analyzes monetary policy asymmetries in EMU participating countries. In particular, we use a structural dynamic modelling approach to investigate asymmetric monetary transmission in Europe. Asymmetries are investigated in two different ways. First, we restrict the estimated structural models reflecting the monetary constraints each country faced during the EMS period. We obtain well-behaved and comparable effects of monetary policy shocks. Second, efficiency frontiers for the selected EMU countries are estimated. In computing the optimal combinations of output gap and inflation volatility we use a weighted average of interest rate and exchange rate, i.e. the Monetary Condition Index (MCI), as a policy instrument. The impulse response analysis implemented with the MCI shows relatively small differences in the responses of the real economy to monetary policy shocks. Altogether the results suggest that, no matter which policy instrument is used, output gap and inflation respond to identical monetary shocks with a similar speed and movement, albeit with a different degree of effect. [ABSTRACT FROM AUTHOR]

This article examines the regime changes in the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS), applying the duration model approach to weekly data of eight currencies participating in the ERM, covering the complete EMS history. When using the non-parametric (univariate) analysis, it was found that for those regimens with long durations, the ERM would have been relatively stable, while for the (more common) regimes associated with short durations would have been more unstable. The probability of maintaining a certain regime is estimated to be 0.685. When applying a parametric (multivariate) analysis to investigate the role of other variables in the probability of a regime change, it is concluded that the interest rate differential with Germany and the magnitude of the realignment would have negatively affected the duration of a given regime, while credibility would have positively influenced such duration. Finally, when distinguishing between groups of currencies, it is observed that those in the core are more stable than those in the periphery, obtaining evidence against equality of survival functions among these groups of currencies. [ABSTRACT FROM AUTHOR]

With persistence in macroeconomic variables two aspects of exchange rate credibility emerge whose relative importance varies over time. Both aspects have opposite implications for the relation between fundamentals and credibility. Hence, the effect of policy measures on interest rate differentials becomes ambiguous. In this paper a Markov-switching VAR that allows for parameter shifts across regimes is employed to test the hypothesis of regime-dependent determination of credibility for major EMS currencies. Regime-dependent impulse response functions reveal substantial differences in the response of spreads to macroeconomic shocks across regimes. [ABSTRACT FROM AUTHOR]

Provides information on the monetary policy of the European Central Bank (ECB). Role of the ECB in the introduction of the actual euro notes and coins; Factors that contributed to the changes in interest rates; Strength of the exchange rate throughout 2002.

The paper examines a long–run (neoclassical) framework in which differences in productivity growth across sectors and countries lead to inflation differentials. In a currency union, these inflation differentials imply cross–country differentials in real interest rates. The authors estimate the likely size of these differentials for European Union countries, discuss the potential costs of persistent inflation differentials, and comment on the conflicts they may cause within Economic and Monetary Union (EMU). The analytical framework is a variant of the Balassa–Samuelson “productivity hypotheisis,” which relates sectoral productivity trends to trends in the relative price of home goods. [ABSTRACT FROM AUTHOR]

This article presents information on the role played by monetary policy in economic development. The monetary conditions in the euro area are currently neutral; in other words they are not a barrier to growth equal to the expansion of potential output. The European Central Bank (ECBs) recent interventions in favor of the euro on the foreign exchange market are a signal with which the ECB supports the turnaround in the euro exchange rate expected on the basis of the economic fundamentals. Since the early November of last year the ECB has raised the refinancing rate in seven steps by a total of 2.25 percentage points to currently 4.75%. Three-month money market rates have risen to 5%, while lending rates have also increased perceptibly. The 2.25% increase in trend potential-output growth assumed for the euro area is low compared with other calculations. The International Monetary Fund, for example, estimates a 2.5% increase in potential output in the euro area. The appreciation of the euro has failed to materialize. In fact the euro has depreciated further, especially against the US dollar.

The evolution of the euro since its inception has appeared inexplicable. This paper develops a monetary model of the euro/US dollar exchange rate to track the progress of the currency, both before and after Stage 3 EMU. The relationship between the exchange rate, money stocks, GDP, interest and inflation rates, and prices is identified. The observed patterns of behaviour during the 1990s are used to predict the euro's value up to mid-2000; a consistent finding is that the euro is over-predicted by 23-30%. This finding is robust to the use of alternative sample periods and alternative estimation methodologies, as long as each of the variables is treated as endogenous. This monetary model does not give much weight to factors such as productivity. However, the past evolution of European exchange rates suggests that productivity trends are indeed important. Some estimates suggest that an annual one percentage point in the intercountry differential in tradable-nontradable productivity causes a 0.85-1.7% real appreciation of a currency. Since recent sectoral productivity data are unavailable, we rely upon potential GDP measures to assess likely trends in the euro. We conclude that without an upward shift in Euroland potential growth, the euro will tend to depreciate over time. [ABSTRACT FROM AUTHOR]

Greece is now on course for European and Monetary Union (EMU), having recently made a formal application to join the single currency area. In recent years, largely ignored by public opinion in the rest of Europe, Greece has mastered a number of thorny economic problems of both structural and cyclical nature. The article provides a brief analysis of the country's economic development and the extent to which it has met the Maastricht criteria, facilitating an evaluation of the opportunities and risks facing Greece in connection with the introduction of the euro. The key economic data of Greece is presented taking into account real GDP, private consumption, fixed capital formation, exports, imports, consumer price index, and unemployment rate. The article concludes that as early as January 1, 2001 a twelfth country will join the circle of EMU Member States--Greece. This would facilitate the country's ongoing convergence process to the extent that it would remove the influence of speculation on exchange rate fluctuations.

We show that within Bertola and Svensson's second-generation target zone model, mean-reverting interventions and endogenous devaluation risk are closely interrelated. Over the period 1983-93 we analyze the degree of mean reversion in the underlying fundamental process as well as the term structure of interest rate differentials vis-a-vis Germany for six Exchange Rate Mechanism currencies. For Austria, Denmark and the Netherlands, and for Belgium after 1990 our estimates are broadly in line with the first-generation target zone model, whereas those for France and Italy are in accordance with the model that allows for endogenous devaluation risk. (JEL F31, E43) [ABSTRACT FROM AUTHOR]

We extend Svensson's (1991b) analysis of the term structure of interest rate differentials in a target zone. First, the model includes a time-varying devaluation risk, and second, we analyse the term structure of interest differentials vis-a-vis Germany in five countries: Belgium, Denmark, France, Italy and the Netherlands. In our sample, 1983-1993, we differentiate between stable and unstable periods. The findings for Denmark and the Netherlands, and for Belgium in the relatively stable period are broadly in line with Svensson's theory, whereas the other results are more in accordance with the model that allows for a time-varying devaluation risk. (J.E.L. E43, F31). [ABSTRACT FROM AUTHOR]

In the early hours of August 1, 1993, weary European Monetary System (EMS) officials reluctantly adopted the deep bands of fluctuations around unchanged central parities. The new bands avoided a complete breakdown, possibly a fatal blow to the wider objective of a single currency. The official communiqué implied that the temporary widening of the margins of fluctuations was a tactical retreat in the face of a year-long series of attacks. Soon afterwards, though, a new, more upbeat view, emerged, presenting the deep bands as the definitive solution to increased financial-market instability. This article looks into the actual behavior of the new EMS as revealed by daily exchange-rate data. The estimates indicate that the new deep bands adopted in 1993 conceal the adoption of narrower bands, which are typically not centered around the official parity. The current system has a number of advantages, which are contrary to the spirit of the old EMS. First, the bands may be moved at the authorities' discretion. Authorities no longer offer one-way bets to speculators. The cost of frequently changing the bands is a loss of credibility and possibly higher volatility in the interest rate or a higher exchange-rate premium. Second, contrasting with the countries, which suspended participation to exchange-rate mechanism of the EMS, the system of deep bands has exerted a stabilizing effect on exchange rates.

Provides information on the determinants of interest rates in European Union countries. Link between prices, interest rates and exchange rates; Concept of purchasing power parity (PPP) in the context of international economy; Conclusions.

This paper examines currency substitution (CS) and the incentive for European monetary union. In the standard money demand study, interest rates are entered as the opportunity cost of holding money. Thus, if foreign interest rates enter significantly in a standard money demand function, this is interpreted as evidence of CS. Since money services may be provided by either domestic or foreign money, the domestic money demand function includes both domestic and foreign variables. With no CS, the standard floating exchange rate scenario is one of a stable money demand function for each currency that is independent of external nominal shocks. Since the issue of CS is relevant for policy under floating exchange rates, the money demand functions will be estimated over the 1973-80 period. The key variables for testing the hypothesis of CS are the money quality or inflation uncertainty variables. Foreign money yields a pecuniary return only because of exchange rate changes. The money quality proxies suggest that there is substitutability between the pound and the franc in the British regression, the mark and all three foreign alternatives in the German regression, and the lira and the franc and mark in the Italian regression.

The primary objective of the paper is to establish that international portfolio capital flows are sensitive to changes in the international constellation of real interest rates. In calculating those real interest rates, the study emphasizes inflationary expectations operating through exchange rate expectations. The U.S. real rate enters every country's demand for foreign assets equation, consistent with the expectation that most foreign portfolio holdings are dominated by the U.S. liabilities and are correspondingly sensitive to changes in the U.S. real yields. The counterpart to this last observation is the significance of the U.S. real rate in the U.S. equation for liabilities to foreigners. All asset equations include the domestic rate as significant, indicating the sensitivity of domestic investors to the return on domestic assets. The adjustment speeds in the liability equations tend to be higher than those in the asset equations. This observation may reflect subtle difference in the substitution processes being modeled on the asset and liability sides.

In the spectrum of alternatives that includes both flexible and fixed exchange rates, currency areas and monetary unions both fall into the general category of fixed exchange rates. But whereas a currency area involves two or more currencies fixed to one another, a monetary union implies an agreement to share a common currency. A distinction between "true" and "pseudo" currency areas may be useful. The former is applied to systems like bimetallism and the gold standard which contained an automatic adjustment and a commitment to stability that, in times of peace, was virtually absolute. The Bretton Woods arrangements and also the Exchange Rate Mechanism of the European Monetary System, however, are better characterized as pseudo currency areas, insofar as countries do not allow the automatic adjustment mechanism to operate and parities can be changed relatively easily by ministerial decisions. Under a true currency area, interest rates tend to converge, and speculation is stabilizing; but under a pseudo currency area, interest rates diverge by an extent determined by expected exchange-rate changes, and speculation, based typically on a one-way option, is destabilizing.

Investigates the status of capital markets in Europe. Hike in interest rates; Development of a unified European capital market that could raise funds for the continent's economies; Devices created for protection against fluctuating exchange rates.

Through multifractal detrended moving-average cross-correlation analysis (MF-X-DMA) and partial moving-average cross-correlation coefficient analysis (PDMCA), this paper studies power-law cross-correlations between renminbi (RMB) onshore and offshore markets (2013–2018). The interaction between CNY and CNH market pairs was examined with attention to how the floating exchange rate regime reform of August 11, 2015 affects their interactions. The obtained results suggest that net power-law cross-correlations exist between the CNY and CNH exchange markets (with influences of autocorrelation, interest rate difference, US Dollar, and Oil signals removed) and that the August 11, 2015 (referred to as "811") exchange reform significantly affects the trend of multiscale cross-correlation coefficient curves. This study also verifies that the risk of offshore RMB markets in Europe and the UK is larger than in Hong Kong and the US when facing a large shock. The nonlinear causal effect analysis reveals that asymmetric bidirectional nonlinear causality exists between any market pair, and the degree of asymmetry appears to have declined after the 811 exchange rate regime reform. For the offshore RMB markets in the US, Europe, and UK, there is evidence of stronger causality running from the CNH to CNY than vice versa, which implies that the foreign impulses have had an influence on the domestic market, and the floating exchange rate reform effectively improves the RMB exchange rate formation mechanism. • We examine the net power-law cross-correlations between onshore and offshore renminbi exchange markets. • Asymmetric bidirectional causality between the onshore and offshore exchange rates is found. • The floating exchange rate reform effectively improves the RMB exchange rate formation mechanism. [ABSTRACT FROM AUTHOR]

Different European countries pay very different interest rates on their public debts. Will these differences disappear if and when exchange rates come to be irrevocably fixed in the European Monetary Union? Or rather will default risks in the high debt countries keep interest rates from converging? To answer this question, this paper investigates whether a perceived default risk is already priced by the market. The paper compares the interest rates on public and private financial instruments denominated in the same currencies in 12 OECD countries. A strong correlation is found between the size of public indebtedness and the spread between public and private rates of return. This correlation suggests that the markets perceive a default risk on the public debt of some OECD countries. The size of this default risk is however very small. [ABSTRACT FROM AUTHOR]