International Finance Discussion Papers (IFDP)
February 1986
The Prospect of a Depreciating Dollar and Possible Tension Inside the EMS
Jacques Melitz
Abstract:
This paper analyses the possibility of increased tensions in the European Monetary System (EMS) as a result of the recent dollar depreciation. The analysis employs a static, fairly stylized macroeconomic model in which the EMS is characterized as a means of achieving a cooperative outcome even though policymakers in member countries weigh output-inflation tradeoffs differently. Compared with the Nash (noncooperative) equilibrium, such cooperation is shown to have been welfare-improving for member countries before the depreciation of the dollar began. However, the inflationary consequences of the dollar depreciation in Europe give rise to the possibility that even if there is an optimal realignment afterwards, the members will not be able to achieve a better output-inflation tradeoff within the EMS than outside of it.
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