Is the EMS a DM zone - evidence from the realignments

Abstract

Most analysis of the relative importance of different countries in the EMS has focused on the interaction of monetary policies. This paper addresses more directly the interdependence of exchange markets. Guided by the desire to know to what extent developments in one EMS country can influence the value of another's currency, we look at exchange rate movements around realignments. We find no evidence of a systematic effect of realignments on the US dollar/DM rate, while the US dollar value of other currencies has clearly changed as a result of the realignments. Furthermore, realignments have tended to influence the forecastability of the US dollar/DM rate less than that of other EMS currency/dollar rates. We conclude that the realignments provide no evidence against the proposition that the DM is a dominant currency, and that movements in the other member currencies have little effect on the external value of the DM. In this limited sense, we maintain that the EMS is a DM zone.