EMU and Long Interest Rates in Germany

Abstract

Has the expectation that monetary policy might in the foreseeable future be in the hands of a European monetary institution maintained long interest rates in Germany at higher levels then they would otherwise be? Since the future European Central Bank (ECB) might be expected to adopt some weighted average of the traditional monetary policy stances of its members—tougher than most, perhaps, but not as tough as the Bundesbank, implying higher expected inflation and perhaps credibility premia—this idea has a fair amount of intuitive appeal. Moreover, it is consistent with three sets of facts, which have each received considerable attention in recent months: First, opinion polls indicate that a large majority of Germans (almost two-thirds, according to a September 1995 report in The Economist) oppose a common currency, presumably because the D-Mark has a track record of stability while the future European currency does not². If this view is shared by financial markets, it could contribute to relatively high long yields.