Macroeconomic Instability in the European Monetary System?

This paper analyses the impact of the establishment of the European Monetary System (EMS) on a number of macroeconomic variables, such as exchange rates, money, interest rates and prices for member countries participating in the Exchange Rate Mechanism (ERM). We examine the instability in terms of multiple structural breaks in the variance of the series. To that end, we employ two procedures: the OLS-based tests to detect multiple structural breaks, proposed by Bai and Perron (1998, 2003) and several procedures based on Information Criterion joint with the so called sequential procedure suggested by Bai and Perron (2003). Results indicate that there is some evidence of structural breaks in volatility across investigated variables, playing the realignments in the ERM a significant role in the reduction of volatility in some countries and sub-periods. In this sense, the results tend to support the hypothesis that the EMS has contributed to reduce the macroeconomic volatility of the member countries.