Dynamics of Intra-ems Interest Rate Linkages

A number of previous studies have questioned the dominant role of Germany within the EMS. These conclusions are often based on empirical findings that interest rates of member countries of the EMS are not affected by German interest rates, even in the long run. In this study we establish evidence to the contrary by demonstrating that intra-EMS interest rate differentials (vis-a-vis Germany) exhibit mean-reverting behavior characterized by long-memory dynamics. Fractional error correction models' estimates suggest the presence of short-run intra-EMS monetarypolicy interdependencies, but they validate the German Dominance Hypothesis i n the long run. * Corresponding author: Tel.: 617-5523673, fax: 617-5522308, e-mail address: [email protected]. We are grateful to Tairi Room for expert research assistance.