Exchange Rates and the EMS: Assessing the Track Record

This paper attempts to provide some answers to a number of related questions. Has the European Monetary System reduced (real or nominal, bilateral or effective) exchange rate volatility? If so, has this been at the expense of increased interest rate volatility? How important have capital controls been for the operation of the EMS? Has the Exchange Rate Mechanism reduced the volatility of unanticipated exchange rate changes? Has the EMS been effective in making ERM currencies close substitutes? What have been the implications of the EMS for the longer-run stabilization of real exchange rates? Because of the uncertainty surrounding the statistical distributions of changes in asset prices in general and exchange rates in particular, an innovative theme of the paper is the use of nonparametric or semi-nonparametric econometric and statistical procedures wherever possible. An exception to this is in our analysis of shifts in the conditional variance of exchange rate changes, where we estimate autoregressive conditionally heteroskedastic (ARCH) parameterizations.