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The Maastricht Convergence Criteria and Optimal Monetary Policy for the EMU Accession Countries

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  • Anna Lipinska

Abstract

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 inflation 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.

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Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0808.

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Date of creation: Jul 2007
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Handle: RePEc:cep:cepdps:dp0808

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Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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Keywords: Optimal monetary policy; Maastricht convergence criteria; EMU accession countries;

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Cited by:
  1. Susanu, Monica, 2009. "Convergence to EMU through the Test of the Public Finance –Romania’s Budgetary Deficit and Public Debt," MPRA Paper 20480, University Library of Munich, Germany.
  2. Hlavac, Marek, 2010. "Has EU Enlargement Been, and Will It Continue to Be, a Success? An Evaluation of EU Enlargement's Effects on Policies Pursued by Candidate Countries," MPRA Paper 28075, University Library of Munich, Germany.
  3. Assoc. Prof. Anca Tãnasie Ph.D & Lect. Rãzvan Tudor Tãnasie PhD, 2011. "An Algorithm Based Approach For Romania’S Road Towards The Euro-Area Membership Status. In Search Of A Suitable Example," Revista Tinerilor Economisti (The Young Economists Journal), University of Craiova, Faculty of Economics and Business Administration, vol. 1(17), pages 133-140, November.
  4. Holger Wolf, 2012. "Eurozone entry criteria after the crisis," International Economics and Economic Policy, Springer, vol. 9(1), pages 1-6, March.
  5. Sandu Carmen, 2009. "Possible Implications Of Adopting The Single European Currency For The Romanian Economy," Annals of Faculty of Economics, University of Oradea, Faculty of Economics, vol. 3(1), pages 328-335, May.
  6. Okano, Eiji, 2014. "How important is fiscal policy cooperation in a currency union?," Journal of Economic Dynamics and Control, Elsevier, vol. 38(C), pages 266-286.

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