Lipinska, Anna (2006): The Maastricht convergence criteria and optimal monetary policy for the EMU accession countries.
Download (374Kb) | Preview
The EMU accession countries are obliged to fulfill the Maastricht convergence criteria prior to entering the EMU. What should be the optimal monetary policy satisfying these criteria? To answer this question, the paper proposes a DSGE model of a two-sector small open economy. First, I derive the micro founded loss function that represents the objective function of the optimal monetary policy not constrained to satisfy the criteria. I find that the optimal monetary policy should not only target in�ation rates in the domestic sectors and aggregate output fluctuations but also domestic and international terms of trade. Second, I show how the loss function changes when the monetary policy is constrained to satisfy the Maastricht criteria. The loss function of such a constrained policy is characterized by additional elements penalizing fluctuations of the CPI inflation rate, the nominal interest rate and the nominal exchange rate around the new targets which are different from the steady state of the unconstrained optimal monetary policy. Under the chosen parameterization, the optimal monetary policy violates two criteria: concerning the CPI inflation rate and the nominal interest rate. The constrained optimal policy is characterized by a deflationary bias. This results in targeting the CPI inflation rate and the nominal interest rate that are 0.7% lower (in annual terms) than the CPI inflation rate and the nominal interest rate in the countries taken as a reference. Such a policy leads to additional welfare costs amounting to 30% of the optimal monetary policy loss.
|Item Type:||MPRA Paper|
|Institution:||Centre for Economic Performance, LSE|
|Original Title:||The Maastricht convergence criteria and optimal monetary policy for the EMU accession countries|
|Keywords:||Optimal monetary policy; Maastricht convergence criteria; EMU accession countries|
|Subjects:||F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F41 - Open Economy Macroeconomics
E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E52 - Monetary Policy
|Depositing User:||Anna Lipinska|
|Date Deposited:||15. Feb 2007|
|Last Modified:||13. Feb 2013 18:06|
 Altissimo F., Benigno P., Rodriguez - Palenzuela D. (2004), Inflation di¤erentials in a currency area: facts, explanation and policy, mimeo  Aoki K. (2001), Optimal monetary responses to relative price changes, Journal of Monetary Economics  Arratibel O., Rodriguez - Palenzuela D., Thimann C. (2002), Inflation dynamics and dual inflation in accession countries: a new Keynesian perspective, ECB Working Paper 132  Backus D. K., Kehoe P. J., Kydland F. E. (1992), International Real Business Cycles, Journal of Political Economy  Balassa B. (1964), The purchasing power parity doctrine: a reappraisal, Journal of Political Economy 72  Benigno G., Benigno P. (2006), Designing Targeting Rules for International Monetary Policy Cooperation, Journal of Monetary Economics, Vol. 53 Issue 3  Benigno G., Thoenisen C. (2003), Equilibrium exchange rates and supply side performance, The Economic Journal 113  Benigno P. (2001), Price stability with imperfect �nancial integration, CEPR Working Paper  Benigno P. (2004), Optimal monetary policy in a currency area, Journal of International Economics, Vol. 63, Issue 2  Benigno P., Lopez - Salido D. (2003), Inflation persistence and optimal monetary policy in the euro area, ECB Working Paper no. 178 30  Benigno P., Woodford M. (2005), Inflation Stabilisation and Welfare: the case of a distorted steady state, Journal of the Europeand Economic Association  Buiter W., Grafe C. (2002), Anchor, float or abandon the ship: exchange rate regimes for accession countries, CEPR Discussion Paper 3184  Canzoneri M., Cumby R., Diba B. (1999), Relative labour productivity and the real exchange rate in the long run: Evidence from a panel of OECD countries, Journal of International Economics 47  Chari V.V., Kehoe P., McGrattan E. (2002), Can sticky price models generate volatile and persistent real exchange rates?, Review of Economic Studies, Vol. 69, No. 3  Cipriani M. (2001), The Balassa-Samuelson e¤ect in transition economies, mimeo, IMF, September  Coricelli F. (2002), Exchange rate policy during transition to the European Monetary Union, Economics of Transition 10 (2)  Coricelli, F, Jazbec B. (2001), Real exchange rate dynamics in transition economies, CEPR Discussion Paper, no 2869  Corsetti G., Dedola L., Leduc S. (2003), International risk sharing and the transmission of productivity shocks, Federal Reserve Bank of Philadelphia Working Paper No. 03-19  Corsetti G., Pesenti P. (2001), Welfare and Macroeconomic Interdependence, The Quarterly Journal of Economics  de Broek M., Sloek T.(2001), Interpreting real exchange rate movements in transition countries, IMF Working Paper 01/56  de Paoli B. (2004), Monetary policy and welfare in a small open economy, CEP Discussion Paper 639  Devereux M. B. (2003), A macroeconomic analysis of EU accession under alternative monetary policies, Journal of Common Market Studies vol.41 no.5  Domowitz I., Hubbard G., Peterson B. (1988), Market structure and cyclical fluctuations in U.S. manufacturing, Review of Economics and Statistics  Duarte M., Wolman A. (2002), Regional inflation in a currency union: �scal policy vs. fundamentals, ECB Working Paper No. 180  Egert B., Drine I., Lommatzsch K., Rault C. (2002), The Balassa-Samuelson e¤ect in central and eastern Europe: myth or reality, William Davidson Institute working paper, no. 483 31  Ferreira Lopes A. (2006), The costs of EMU for transition countries, mimeo  Fischer C. (2002), Real currency appreciation in accession countries: Balassa-Samuelson and investment demand, Deutsche Bundesbank discussion paper, no. 19/02.  Froot K., Rogoff K., (1995), Perspectives on PPP and long - run real exchange rates, Handbook of International Economics vol. 3, Gene Grossman and Kenneth Rogo¤ (eds.)  Gali J., Gertler M., Lopez - Salido D. (2001), European inflation dynamics, European Economic Review 45  Gali J., Monacelli T. (2005), Monetary policy and exchange rate volatility in a small open economy, Review of Economic Studies  Giannoni M., Woodford M. (2003), Optimal inflation targeting rules, NBER Working Paper No. W9939  Halpern L., Wyplosz C. (2001), Economic transformation and real exchange rates in the 2000s: the Balassa-Samuelson connection, Economic Survey of Europe, no. 1, Geneva, United Nations Economic Commission for Europe.  Laxton D., Pesenti P. (2003), Monetary rules for small open, emerging economies, Journal of Monetary Economics 50 pp. 1109-1146  Liu Z., Pappa E. (2005), Gains from international monetary policy coordination: Does it pay to be different?, European Central Bank Working Paper No. 514  Maastricht Treaty (1994), European Commission webpage  Marimon R., Zilibotti F. (1998), Actual versus virtual unemployment in Europe: is Spain different?, European Economic Review 42  Martins J., Scarpetta S., Pilat D. (1996), Mark - up pricing, market structure and the business cycle, OECD Economic Studies 27  Mihaljek D., Klau M. (2004), The Balassa - Samuelson e¤ect in central Europe: a disaggregated analysis, BIS Working Paper 143  Morrison C. (1994), The cyclical nature of markups in Canadian manufacturing: a production theory approach, Journal of Applied Econometrics 9  Natalucci F., Ravenna F. (2003), The road to adopting the Euro: Monetary policy and exchange rate regimes in EU accession countries, Federal Reserve Board International Finance Discussion Paper 741 32  Obstfeld M., Rogo¤ K. (1999), New directions for stochastic open economy models, NBER Working Paper 7313  Ravenna F. (2005), The European Monetary Union as the commitment device for new EU member states, ECB Working Paper no. 516  Rotemberg J., Woodford M. (1997), An optimization-based framework for the evaluation of monetary policy, in Ben S. Bernanke and Julio J. Rotemberg (eds.), NBER Macroeconomics Annual 1997  Rotemberg J., Woodford M. (1999), Interest rate rules in an estimated sticky price model, NBER Working Paper  Smets F., Wouters R. (2004), An estimated stochastic dynamic general equilibrium model of the euro area, Journal of the European Economic Association, Vol. 1, Issue 5  Stahl H. (2003), Price rigidity in German manufacturing, unpublished manuscript  Stockman A., Tesar L. (1994), Tastes in a two - country model of the business cycle: explaining international comovement, American Economic Review vol. 85, No. 1  Sutherland A. (2002), A simple second-order solution method for dynamic general equilibrium models" CEPR Discussion Paper No 3554  Woodford M. (2003), Interest and prices: Foundations of a theory of monetary policy, Princeton University Press