Convergence from Inflation Targeting to Euroisation

Abstract:     
This Chapter presents an overview of the fundamental goals and economic effects of divergent strategies applied by the six leading EU candidates, namely Poland, the Czech Republic, Slovakia, Hungary, Slovenia and Estonia. The general assumption is that the applicants with well-developed and sufficiently competitive financial markets and institutions are wise to initiate the monetary convergence process with the introduction of direct inflation targeting (DIT). Such policy facilitates successful disinflation and sustainable price stability relative to the eurozone. DIT reinforces commitment to containing inflation in the presence of the ongoing serious challenges to price stability posed by the Harrod-Balassa-Samuelson effect and the resulting large capital inflows. The key argument advanced in this Chapter is that the EU candidates are yet to develop efficient means of managing the inflation risk, the default risk, and the exchange rate risk, as an important prerequisite to securing financial stability. Some benchmarks reflecting their ability to manage these risks are proposed as criteria of their successful convergence that could supplement the standard Maastricht criteria. Once satisfactory price stability and a sufficient 'foundational credibility' of monetary policy are achieved, a gradual convergence of exchange rates and interest rates to the eurozone may begin.

JEL Classification: E61, P20

Accepted Paper Series