Academic journal article Review - Federal Reserve Bank of St. Louis

The Big Mac and the European Exchange Rate Mechanism

Academic journal article Review - Federal Reserve Bank of St. Louis

The Big Mac and the European Exchange Rate Mechanism

Article excerpt

The figure to the right presents PPP information for the currencies in the Exchange Rate Mechanism (ERM) of the European Monetary System relative to the German mark. The upper panel shows the PPP behavior of the currencies at the core of the ERM, and the lower panel considers the weaker currencies in the ERM. Once again, there are substantial persistent deviations from absolute PPP In general, the core currencies have been overvalued relative to the mark. The Dutch guilder has been closest to parity over most of the sample period, and the Danish kroner has been the most overvalued of the four currencies. The 1995 PPP index numbers for the core currencies, with the exception of the Danish kroner, lie within the fluctuation bands permitted under the ERM.

As one would expect, the core currencies have been closer to parity with the mark than the weak currencies (again with the exception of the Danish kroner). The lower panel shows that before its October 1990 entry into the ERM, the pound was undervalued against the mark. During the two years (1991-92) in the sample in which the pound was a member of the ERM, it was overvalued against the mark. …

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