Interest rate convergence in the EMS prior to European Monetary Union

Abstract

In this paper we analyze the convergence of interest rates in the European Monetary System (EMS) in a framework of changing persistence. This allows us to estimate the exact date of full convergence from the data. A change in persistence means that a time series switches from stationarity to non-stationarity, or vice versa. It is often argued that due to the specific historical situation in the EMS the interest rate differential was non-stationary before the full convergence of interest rates was achieved and stationary afterwards. Our empirical results suggest that the convergence date has been very different for Belgium, France, the Netherlands and Italy and are in line with the conclusions one would draw from a narrative approach. We compare three different estimators for the convergence date and find that the results are quite robust. Our results therefore stress the importance of credibility for monetary policy.

Explosive behaviour and long memory with an application to European bond yield spreads

“…However, crises in Europe might have also stopped convergence among these government bond yields – for example, due to safe‐haven effects. Furthermore, this finding corresponds with the empirical results by Frömmel and Kruse () before the advent of the Euro and with Sibbertsen et al . () for the time during the financial crisis.…”

Testing for a break in the persistence in yield spreads of EMU government bonds

“…As already discussed, Frömmel and Kruse (2009) Leybourne, Taylor and Kim (2007) to allow for long memory dynamics. Under the null hypothesis of this test there is no change in the persistence against the alternative that the persistence breaks…”

“…More recently, Frömmel and Kruse (2009) Many econometricians have also examined data before 1990 arguing that the Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) already could have caused convergence of interest rates in Europe 4 (e.g., Siklos and Wohar, 1997;Baum and Barkoulas, 2006). Because of this institutional arrangement -with reducing exchange rate risk -German government bond yields ought to have played a special role for the European bond markets thereby "causing" interest rate movements in other ERM countries.…”

Convergence patterns in sovereign bond yield spreads: Evidence from the Euro Area

“…For example, the possible existence of structural breaks in yield spreads has also been taken into account in the literature (e.g. Frömmel and Kruse, 2009), while the persistence in bond yields has also been tested using fractional integration techniques (Baum and Barkoulas, 2006;Sibbertsen et al, 2014). Sibbertsen et al (2014) examine the persistence in government bond yield spreads in France, Italy and Spain (relative to Germany) over the period 2002-2012 finding evidence of both breaks between 2006 and 2008, and an increase in the persistence of yield spreads after those breaks, coinciding with the sovereign debt crisis.…”