Realignment probabilities and reputation effects in the EMS

This paper examines the existence of reputation effects in the EMS and their impact on the probability of realignment. By reputation effects we mean effects which, controlling for all other determinants of realignment, reduce the probability of realignment simply because the monetary authorities have avoided realignment in the past. Our results provide support for the idea that realignments are dependent on macroeconomic conditions, as suggested by theory, and hence a countryʹs participation in a target zone system could become more credible if macroeconomic conditions are improved. There is less evidence, however, of an independent role for reputation effects.