Rationality of inflationary expectations in the European Economic Communities Countries

Empirical assessment of rationality of inflationary expectations has attracted considerable interest. However no conclusive evidence has emerged in favour nor against the hypothesis of rationality. In this paper a new set of data is used to test the weak-form rationality of survey based expectations for a fairly large group of countries with very different inflationary experiences. The empirical tests carried out in the paper show that two necessary conditions of weak-form, linear rationality are met for four of the seven countries in the sample: France, Germany, Netherlands and Belgium, which happen to be the countries with relatively stable and low rates of inflation. This conditions are not, however, met in the case of Italy and Denmark, with the U.K. being a marginal case. The interpretation of these results is left open in the paper.     

Forward exchange rates as predictors of future spot rates and the efficiency of the foreign exchange market

The theory of informationally efficient markets (EMIT) is applied to the foreign exchange market and some of its operational implications are illustrated. The EMIT is joined with alternative models of the equilibrium return on the foreign exchange market: the Pure Expectations Hypothesis, the Modern Theory and tentative formulations of return as a function of risk. The alternative joint Hypotheses are rejected by the data but this does not necessarily imply the rejection of EMIT. The rejection may be due to the inadequacies of the equilibrium return models used, notwithstanding the fact that the risk premium has been captured, to a certain extent, in the empirical tests and the evidence against the EMIT weakened.     

Central Bank Independence and Budget Constraints for a Stable Euro

This paper looks at what economic theory and empirical evidence have to offer about the institutional conditions that are most likely to lead to a stable currency. Both theory and evidence suggest that an independent central bank with the explicit mandate to pursue price stability provides an effective solution to the time-inconsistency problem. The EMU institutional set-up is well-equipped to support a stability-oriented monetary policy. The ECB appears to be the most independent central bank in the world. An added protection of monetary policy from the influence of unsound budgetary policies enhances the prospects of price stability. The Maastricht Treaty and the Pact for Stability and Growth provide effective constraints against excessive deficits and encourage an environment of balanced budgets. The argument that both strong institutional arrangements and sound economic policy-making stem from a conservative attitude of the public is not dismissed altogether in this paper. We note, however, that this hypothesis is not formulated in a testable form and has ambiguous practical consequences. The hypothesis, nonetheless, serves as a useful reminder that the ECB should endeavor to draw its legitimacy not only from the text of the Treaty, but also from society as a whole.