Interest rate convergence in the EMS prior to European Monetary Union

We analyze the convergence of interest rates in the European Monetary System (EMS) in a novel framework of changing persistence. Due to the specific historical situation in the EMS interest rate differentials were non-stationary before full convergence was achieved. After full convergence has taken place, interest rate differentials became stationary. The applied econometric approach allows us to estimate the exact dates of full convergence endogenously. Our empirical results suggest remarkable differences in the estimated convergence dates for Belgium, France, the Netherlands and Italy which are highly related to steps of European integration policies. We conclude that credibility of monetary policy is of paramount importance for establishing a monetary union successfully. This finding has significant implications for future member states of the EMU.