The Credibility of the United Kingdom's Commitment to the Erm: Intentions Versus Actions, Issues 94-147The paper presents estimates of a model of the credibility of the U.K. commitment to its central parity against the deutsche mark during the period of U.K. ERM membership (1990-92). The measure of credibility used is the long-term interest differential with Germany. Credibility is decomposed into two aspects: an assessment of whether the government was truly committed to the ERM, and the probability that even a committed government would be able to continue to bear the unemployment costs. Doubts about the first aspect—which could lead to a self-fulfilling crisis—are shown to have declined steadily during the period of ERM membership, while the second aspect is estimated to have become increasingly important, due to rising unemployment. |
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APR MAY JUN Bank of England coefficient concept of credibility costs of maintaining credibility crisis currencies depreciation deutsche mark devaluation probabilities deviation of unemployment differential with Germany disinflation Drazen and Masson equation 16 ERM membership ERM parity error term Et-let European Monetary System exchange rate mechanism exchange rate surprises existing parity expected devaluation FEB MAR APR government is weak government will devalue interest rates join the ERM Kalman filter lack of credibility leave the ERM long-term interest differential loss function maintaining the parity Margaret Thatcher Monetary Policy natural rate Obstfeld paper parameters pound sterling private sector private sector's assessment probabilities of devaluation self-fulfilling crises self-fulfilling speculation September 16 September 1992 shocks to unemployment speculative attack Standard Errors summer of 1992 T-bW tough government type of government U.K. authorities unemployment costs unemployment shock unfavorable shock United Kingdom v-yt variable weak government weight to inflation