Working Paper no. 48

Monetary Policy Independence in the ERM: Was there any?

Hali Edison and Ronald MacDonald (March 2000)

Abstract.
Recently proposals for introducing greater exchange rate fixity into the behavior of key exchange rates have become fashionable. One proposal, for example, suggests that a target zone arrangement for the dollar, mark and yen would represent a desirable reform of the international monetary system. The question we seek to address in this paper is how much monetary independence is likely to be conferred on a country participating in such an arrangement. Recent research for the Classical gold standard has suggested that even with a rigidly fixed exchange rate system there is still some scope for monetary independence. Here we examine the extent of monetary independence conferred by a target zone using data from the recent ERM experience. Amongst our findings is the result that countries which had a credible commitment to the target zone had more independence in the operation of their monetary policy than countries with a lesser commitment. It turns out that the monetary independence for a credible participant in a target zone arrangement is longer than that conferred by participation in a regime of rigidly fixed exchange rates, such as the Classical gold standard.

Ronald MacDonald, MacDonald is Professor of International Macroeconomics at University of Strathclyde. MacDonald co-directs two GEI projects "Unexplained Relationships in Three Regimes of the International Monetary System" and "Optimal International Regimes and global Economic Institutions". Contact: Department of Economics, University of Strathclyde, Glasgow, G4 0LN, UK, tel: (44 141) 548 3861. r.r.macdonald@strath.ac.uk

Hali Edison, Board of Governors, Federal Reserve Board, Hali.Edison@frb.gov