The European Monetary System and Real Interest Parity: Is there any Connection?

This paper examines the proposition whether or not EMS membership is a necessary condition for real interest parity to hold, taking Germany as a reference country. Empirical results indicate that EMS membership is not a necessary condition for convergence on German real interest rates, since the relationship seems to hold best for Switzerland followed by the U.K. Moreover, results obtained from time-varying parameter regressions reveal that Swiss real interest rates have progressively converged on those of Germany since the early 1980s. It is concluded that the important underlying factor is a similarity between the German and Swiss central banks, rather than institutional arrangements like the EMS.