Monetary policy credibility

In this paper we applied the credibility-hypothesis to the Netherlands' exchange rate policy. Since September 1979 Dutch exchange rate policy has been intensified. The policy is now to keep the guilder in the upper part of the EMS band and to strive for an unchanged central rate with the Deutsche mark. Such a policy, if maintained, will lead to a lower premium for currency risk on the guilder vis a vis the DM, resulting in a lower level of Dutch interest rates. By means of two indirect and two direct estimation methods we found support for the credibility-hypothesis. After one year this policy led to a significant and permanent cut in money market rates, amounting to about 1V*%. Further, the public turned out to react to policy results, not merely to policy announcements. We also found evidence the unanticipated devaluation of the guilder vis a vis the DM in the March 1983 realignment was seen as cheating. Free University Amsterdam Faculty of Economics & Econometrics P.O. Box 7161 1007 MC Amsterdam The Netherlands Amsterdam, February 1991