On the European monetary system: the spillover effects of German shocks and disinflation

We analyse the disinflationary experience between 1979-93 for two tradition ally inflationary countries of the European Monetary System: France and Ita ly. For each country, a vector autoregressive model is estimated. Shocks in the model combine domestic and foreign sources. The latter capture the wor ld oil price shocks as well as nominal and real shocks originating in Germa ny. Under investigation is the hypothesis that shocks originating in German y have a spillover disinflationary effect in France and Italy. The empirica l evidence provides support to the validity of this hypothesis. Furthermore , German shocks account for an important share of the total price variance in France and Italy. These results indicate that the interaction between co untries of the European Monetary System has contributed to the success of t he disinflationary experiences of the 1980s. The evidence sheds, therefore, some light on potential benefits that may be further realized as countries of the European Monetary System move towards their objective of achieving a single currency under a united monetary system.