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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.

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.