Inflation Targeting To Achieve Inflation Convergence In The Transition Towards Emu

Countries with evolving monetary regimes that decide to embark on “the Journey to inflation targeting” may not be able to adopt a full-fledged inflation targeting regime immediately. Those countries would be better off adopting transitional arrangements that take advantage of the informational content of monetary aggregates, developing an economic analysis capacity, and concentrating on monetay operations aimed at steering money market interest rates. This approach would allow the central bank to buy time for developing the building blocks for effective monetary policy, support transparent central bank communication, and limit the potential for undesirable outcomes along the road.

This study proposes a sequence of monetary convergence to the eurozone, based on autonomous monetary policy rather than on an early application of the euro-peg. The gradual adjustment process begins with a relatively strict variant of inflation targeting, followed by flexible inflation targeting, and ends with exchange rate targeting. A model outlining the optimal mode of policy adjustment is presented. The analysis warns against a premature peg to the euro, which may instigate real currency appreciation, large capital inflows and their costly sterilization. The euro-peg can be introduced only when the candidates' monetary authorities reach a certain degree of foundational credibility. The model of monetary convergence is followed by the empirical assessment of inflation targeting in the Czech Republic and Poland.

The Maastricht Treaty, signed in December 1991, set a timetable for the European Community's economic and monetary union (EMU) and clearly defined the institutional policy changes necessary for its achievement. Subsequent developments have demonstrated, however, the importance of many key issues in the transition to EMU that were largely neglected at the time. This volume reports the proceedings of a joint CEPR conference with the Banco de Portugal, held in January 1992. In these papers, leading international experts address the instability of the transition to EMU, the long-run implications of monetary union and the single market for growth and convergence in Europe. They also consider the prospects for inflation and fiscal convergence, regional policy and the integration of financial markets and fiscal systems. Attention focuses on adjustment mechanisms with differentiated shocks, region-specific business cycles and excessive industrial concentration and the cases for a two-speed EMU and fiscal federalism.