Macroeconomic Fundamentals and Exchange Rate Credibility. Further Evidence on the Italian Experience from a Regime‐switching Approach

This paper explores the links between exchange rate credibility and macroeconomic fundamentals with reference to the Italian experience during the first half of the 90’s. The analysis relies on a nonlinear framework emphasizing shifts between credible and not credible states, and assuming a significant degree of persistence in the above regimes. We detect a significant influence of a cumulative loss in external competitiveness and of real output dynamics on devaluation expectations. While supporting the cautious monetary policy stance taken by monetary authorities during the transition phase following Italy’s re‐entry in the EMS, our evidence suggests that structural supply‐side policies will become crucial, in the years ahead, to ensure a credible and lasting permanence of Italy inside the EMU.