Exchange Rate Stabilization in the Erm : Identifying European Monetary Policy Reactions

The structural VAR models for European countries (France, Denmark, and Germany) are developed to examine the monetary policy reactions, especially the within-ERM exchange rate stabilization, during the ERM period. First, impulse responses of monetary instrument and the exchange rate to shocks destabilizing the exchange rate, and the variance decomposition of exchange rate due to shocks destabilizing the exchange rate and shocks to the monetary instrument are examined to infer the monetary policy reactions. Second, the full monetary policy reaction functions recovered from the VAR models are presented in an interpretable manner wihtout introducing additional assumptions. The results suggest that some asymmetry in exchange rate stabilization; non-German exchange rate stabilization was stronger than German exchange rate stabilization. However, the results do not support the hypothesis that German monetary policy was independent of the ERM: the Bundesbank also stabilized the within-ERM exchange rate to some extent