Is There an `EMS' Effect in European Labour Markets?

It is claimed that membership of the exchange rate mechanism (ERM) of the European Monetary System (EMS) gives countries a credibility bonus which reduces the output and employment costs of disinflation. Within the EMS this arises because of the commitment of participants in the ERM to maintain their parities against the Deutschmark, with Germany acting as a low-inflation anchor. The paper finds evidence of such a credibility effect: during `the EMS period' (flexibly dated) German inflation enters into autoregressive inflation predictor schemes for each of the main EMS countries (Belgium, France, Germany, Italy, and the Netherlands). In addition, the process of wage determination in these countries appears to have been affected by institutional changes associated with adjustment to the ERM. Nevertheless, there is also a large residual (upward) adjustment of unemployment.