Realignment probabilities and reputation effects in the EMS

This paper examines the existence of reputation effects in theEMS and their impact on the probability of realignment. By reputationeffects we mean effects which, controlling for all other determinantsof realignment, reduce the probability of realignment simplybecause the monetary authorities have avoided realignment inthe past. Our results provide support for the idea that realignmentsare dependent on macroeconomic conditions, as suggested by theory,and hence a country's participation in a target zone systemcould become more credible if macroeconomic conditions are improved.There is less evidence, however, of an independent role forreputation effects.