The EMS, the Emu, and the Transition to a Common Currency

58 Pages Posted: 7 Jul 2004 Last revised: 28 Jul 2010

See all articles by Kenneth Froot

Kenneth Froot

National Bureau of Economic Research (NBER); Harvard Business School

Kenneth Rogoff

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: April 1991

Abstract

When central banks are about to relinquish control over their exchange rate and enter into a currency union, the reptutational costs to devaluation are very low. As with any finite-horizon game, the endpoint affects the earlier expectations of private agents, here causing them to demand higher interest rates and higher wages from countries whose currencies are relatively weak. In looking at the countries within the EMS, we find that Italian long-term interest rates as well as price and wages levels relative to Germany show evidence of growing gaps We also find that the real appreciation of the lira appears to be predominantly due to increases in relative Italian government spending, and not to relatively rapid Italian productivity growth. Taken together, this evidence suggests that convergence within the EMS may have peaked. Furthermore, moving forward the date of currency union may in the short run increase both the growth of the gaps and the need for exchange-rate realignment.

Suggested Citation

Froot, Kenneth and Rogoff, Kenneth S., The EMS, the Emu, and the Transition to a Common Currency (April 1991). NBER Working Paper No. w3684. Available at SSRN: https://ssrn.com/abstract=295666

Kenneth Froot (Contact Author)

National Bureau of Economic Research (NBER) ( email )

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Harvard Business School ( email )

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Kenneth S. Rogoff

Harvard University - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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