Business Cycle and Speculative Pressures in a Target Zone

Abstract

In the past time, most economies have suffered cyclical fluctuations in their activity which may influence the optimal use of productive factors in long slow-growth phases or price stability in periods of fast growth. This paper focuses on the possible interrelationship between business cycles and exchange rate ‡uctuations. We have chosen the European Monetary System framework in the nineties, from June 1989 to December 1998, because the Peseta belonged to the EMS during that time. This sample is specially interesting because it includes the worst crisis of the System in 1992-93 and the following ones affecting emerging countries like Mexico, Brazil or Russia at the end of the decade. We use a Binary Dependent Variable Logit Model to estimate the readjustment probability inside a band for two currencies, the Peseta and the french Franc . We calculate the dependent variable values from a Markov-Switching Regime Model with constant transition probabilities. We prove that it is a suitable method and that it allows both real and monetary variables to be identified in order to explain speculative pressures.Readjustment Probability, Speculative Pressures, Economic Fluctuations.