How To Stabilize Financial Markets Before EMU ?

Abstract

A recent report from the Center for Economic Policy Research (CEPR) has advocated that fixed conversion rates for the start of EMU should be preannounced as soon as possible. The aim of this short paper is to focus on the potential dangers of such a decision. Indeed, the CEPR report propositions are based on the idea that, roughly speaking, fixing a conversion rate in advance should stabilize the exchange rate markets now. We show that this intuition is misleading: knowing the price of an asset at some point in the future has never meant that its current price has a low volatility. Moreover, we perform some simulations to evaluate how volatile exchange rate markets should have been for the past few months if such a rule had been announced. Finally, we provide a constructive proof of what a stabilizing rule should look like.EMU Finance Exchange rate