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Who will join EMU? Impact of the Maastricht convergence criteria on economic policy choice and performance

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  • R. Sean Craig
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    Abstract

    To qualify for European Monetary Union (EMU) countries must meet convergence criteria established in the Maastricht treaty of December 1991. However, an analysis of how difficult it will be to meet the convergence criteria is not sufficient to identify the countries most likely to join EMU in 1999. This paper identifies a number of factors in addition to budget deficit reduction required to qualify for EMU such as; the persistence of inflationary expectations; the variance of output shocks; the inflationary bias to monetary policy; and, the political cost to not joining EMU. Moreover, countries follow a policy rule where a large negative output shocks can cause them to abandon the restrictive policies necessary to qualify for EMU and, instead, use policy for stabilization. Concern about such a policy shift could cause increases in interest rates similar to those observed during ERM crises. Data on the above factors are generally not available, except for budgetary data. However, the model shows that data on long-term interest rate differentials with Germany can serve as a measure of their influence. Two approaches, using implied forward interest rate differentials and econometric analysis, are used to evaluate the usefulness of this measure. Both support the use of long-term interest differentials. Overall, it appears likely that EMU will occur in stages as factors are relatively favorable for EMU in Denmark, France, Ireland and the Netherlands. In contrast, for Italy and Spain EMU appears unlikely.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 480.

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    Date of creation: 1994
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    Handle: RePEc:fip:fedgif:480

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    Related research

    Keywords: Monetary unions - European Union countries;

    References

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    1. Svensson, Lars E. O., 1992. "The foreign exchange risk premium in a target zone with devaluation risk," Journal of International Economics, Elsevier, vol. 33(1-2), pages 21-40, August.
    2. Alberto Alesina & Vittorio Grilli, 1993. "On the Feasibility of a One or Multi-Speed European Monetary Union," NBER Working Papers 4350, National Bureau of Economic Research, Inc.
    3. Buiter, W.H. & Corsetti, G. & Roubini, N., 1992. "Excessive Deficits: Sense and Nonsence in the Treaty of Maastricht," Papers 674, Yale - Economic Growth Center.
    4. Robert J. Barro & David B. Gordon, 1983. "Rules, Discretion and Reputation in a Model of Monetary Policy," NBER Working Papers 1079, National Bureau of Economic Research, Inc.
    5. Andrew K. Rose & Lars E.O. Svensson, 1991. "Expected and predicted realignments: the FF/DM exchange rate during the EMS," International Finance Discussion Papers 395, Board of Governors of the Federal Reserve System (U.S.).
    6. Buiter, W.H., 1992. "Should we Worry About the Fiscal Numerology of Maastricht?," Papers 654, Yale - Economic Growth Center.
    7. Paul R. Masson & Steven A. Symansky, 1993. "Evaluating the EMS and EMU Using Stochastic Simulations," IMF Working Papers 93/28, International Monetary Fund.
    8. Mali J. Edison & Linda S. Kole, 1995. "European monetary arrangements: Implications for the dollar, exchange rate variability and credibility," European Financial Management, European Financial Management Association, vol. 1(1), pages 61-86.
    9. Fratianni, M. & Von Hagen, J. & Waller, C., 1992. "The Maastricht Way to EMU," Princeton Studies in International Economics 187, International Economics Section, Departement of Economics Princeton University,.
    10. Alun H. Thomas, 1994. "Expected Devaluation and Economic Fundamentals," IMF Staff Papers, Palgrave Macmillan, vol. 41(2), pages 262-285, June.
    11. Paul Masson & Jacques Melitz, 1991. "Fiscal policy independence in a European Monetary Union," Open Economies Review, Springer, vol. 2(2), pages 113-136, June.
    12. Ioannis Halikias, 1993. "Testing the Credibility of Belgium's Exchange Rate Policy," IMF Working Papers 93/76, International Monetary Fund.
    13. Torres,Francisco & Giavazzi,Francesco (ed.), 1993. "Adjustment and Growth in the European Monetary Union," Cambridge Books, Cambridge University Press, number 9780521440196, April.
    14. R. Sean Craig, 1991. "EMS interest rate differentials and fiscal policy: a model with an empirical application to Italy," International Finance Discussion Papers 405, Board of Governors of the Federal Reserve System (U.S.).
    15. Robert P. Flood & Peter Isard, 1989. "Monetary Policy Strategies," IMF Staff Papers, Palgrave Macmillan, vol. 36(3), pages 612-632, September.
    16. Vincent Koen, 1991. "Testing the Credibility of the Belgian Hard Currency Policy," IMF Working Papers 91/79, International Monetary Fund.
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    Cited by:
    1. Kazemi, Hossein B. & Warotamasikkhadit, Dolly & Nageswaran, V. Anantha, 1997. "International convergence of short-term and long-term interest rates: Theory and empirical tests," Global Finance Journal, Elsevier, vol. 8(2), pages 239-256.

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