Credibility of Interest Rate Policies in Eight EMS Countries: An Application of the Markov Regime-Switching

Publication date: 29 May 2003 | Publication type: NIESR Discussion Paper | JEL Classification: C32, E52 | NIESR Discussion Paper Number: 223

This paper uses the Markov regime-switching modelling in a bivariate Autoregressive framework to study the credibility of monetary policy in eight member countries of the European Monetary System (EMS) during the period 1979 to 1998. The eight countries are: Austria, Belgium, France, Finland, Italy, the Netherlands, Portugal and Spain; a tenth country, Germany, is used as a benchmark case. The output-gap variability and the inflation variability variables are incorporated in the determination of the preferences of individual member countries of the EMS in the conduct of monetary policy. Our empirical evidence shows that although all countries in our sample follow a credible monetary policy in relation to price stability, not all of them have the same preferences regarding the trade-off between stabilisation of output-gap variability and inflation variability.

Keyword tags: 
credibility, EMS, bivariate Markov regime-switching autoregressive models