Explaining devaluation expectations in the EMS

Ulf Soderstrom, Alexis Stenfors

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    Abstract

    This paper is an attempt to explain devaluation expectations in the ERM with macroeconomic fundamentals. Two different measures of devaluation expectations are used; expectations estimated using the drift-adjustment method of Bertola and Svensson [1993] and the directly observable interest rate differential. The interest rate differential seems more closely connected to macroeconomic fundamentals than the estimates stemming from the drift- adjustment metod. For the ERM as a whole, an expanded theoretic model of exchange rate determination explains a considerable part of the devaluation expectations, whereas for individual countries additional variables are important, and the relationships are ambiguous and country specific.
    Original languageEnglish
    Pages (from-to)63-81
    JournalFinish Economic Papers
    Publication statusPublished - 1995

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