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Exchange Rate Risk and Convergence to the Euro

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  • Lucjan T Orlowski

    (Sacred Heart University)

Abstract

This paper proposes a new monetary policy framework for effectively navigating the path to adopting the euro. The proposed policy is based on relative inflation forecast targeting and incorporates an ancillary target of declining exchange rate risk, which is suggested as a key criterion for evaluating the currency stability. A model linking exchange rate volatility to differentials over the euro zone in both inflation (target variable) and interest rate (instrument variable) is proposed. The model is empirically tested for the Czech Republic, Poland and Hungary, the selected new Member States of the EU that use direct inflation targeting to guide their monetary policies. The empirical methodology is based on the TARCH(p,q,r)-M model.

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File URL: http://128.118.178.162/eps/mac/papers/0501/0501034.pdf
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Bibliographic Info

Paper provided by EconWPA in its series Macroeconomics with number 0501034.

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Length: 34 pages
Date of creation: 28 Jan 2005
Date of revision:
Handle: RePEc:wpa:wuwpma:0501034

Note: Type of Document - pdf; pages: 34
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Web page: http://128.118.178.162

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Keywords: exchange rate risk; inflation targeting; monetary convergence; euro area; new EU Member States;

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References

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  1. Lorenzo Giorgianni, 1997. "Foreign Exchange Risk Premium: Does Fiscal Policy Matter? Evidence from Italian Data," IMF Working Papers 97/39, International Monetary Fund.
  2. Roman Matoušek & Anita Taci, 2003. "Direct Inflation Targeting and Nominal Convergence: The Czech Case," Open Economies Review, Springer, vol. 14(3), pages 269-283, July.
  3. Juraj Valachy & Evžen Ko?enda, 2003. "Exchange Rate Regimes and Volatility: Comparison of the Snake and Visegrad," William Davidson Institute Working Papers Series 2003-622, William Davidson Institute at the University of Michigan.
  4. Ser-Huang Poon & Clive W.J. Granger, 2003. "Forecasting Volatility in Financial Markets: A Review," Journal of Economic Literature, American Economic Association, vol. 41(2), pages 478-539, June.
  5. Orlowski, Lucjan T., 2005. "Monetary convergence of the EU accession countries to the eurozone: A theoretical framework and policy implications," Journal of Banking & Finance, Elsevier, vol. 29(1), pages 203-225, January.
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  8. Ratna Sahay & Gaston Gelos, 2000. "Financial Market Spillovers in Transition Economies," IMF Working Papers 00/71, International Monetary Fund.
  9. Orlowski, Lucjan T., 2004. "Money rules for the eurozone candidate countries," ZEI Working Papers B 05-2004, ZEI - Center for European Integration Studies, University of Bonn.
  10. International Monetary Fund, 2000. "Exchange Rate Regimes in Selected Advanced Transition Economies - Coping with Transition, Capital Inflows, and EU Accession," IMF Policy Discussion Papers 00/3, International Monetary Fund.
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  16. Laurence H. Meyer, 2004. "Practical problems and obstacles to inflation targeting," Review, Federal Reserve Bank of St. Louis, issue Jul, pages 151-160.
  17. Philippe Bacchetta & Eric van Wincoop, 2004. "A Scapegoat Model of Exchange Rate Fluctuations," Working Papers 04.01, Swiss National Bank, Study Center Gerzensee.
  18. Carlo A. Favero & Francesco Giavazzi, 2004. "Inflation Targeting and Debt: Lessons from Brazil," NBER Working Papers 10390, National Bureau of Economic Research, Inc.
  19. Garett Jones & Ali M Kutan, 2004. "Exchange Rate Management Strategies in the Accession Countries: The Case of Hungary," Comparative Economic Studies, Palgrave Macmillan, vol. 46(1), pages 23-44, March.
  20. Balázs Égert & Imed Drine & Kirsten Lommatzsch & Christophe Rault, 2002. "The Balassa-Samuelson effect in Central and Eastern Europe: Myth or reality?," William Davidson Institute Working Papers Series 483, William Davidson Institute at the University of Michigan.
  21. Paul de Grauwe & Gunther Schnabl, 2004. "Nominal versus Real Convergence with Respect to EMU Accession.How to Cope with the Balassa-Samuelson Dilemma," EUI-RSCAS Working Papers 20, European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS).
  22. Kutan, Ali M. & Orlowski, Lucjan T., 2006. "Monetary convergence to the Euro," Economic Systems, Elsevier, vol. 30(4), pages 307-310, December.
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Citations

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Cited by:
  1. Mikek, Peter, 2008. "Alternative monetary policies and fiscal regime in new EU members," Economic Systems, Elsevier, vol. 32(4), pages 335-353, December.
  2. Kocenda, Evzen & Valachy, Juraj, 2006. "Exchange rate volatility and regime change: A Visegrad comparison," Journal of Comparative Economics, Elsevier, vol. 34(4), pages 727-753, December.
  3. Evžen Koèenda & Tigran Poghosyan, 2010. "Exchange Rate Risk in Central European Countries," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 60(1), pages 22-39, February.
  4. Juraj Stanèík, 2007. "Determinants of Exchange-Rate Volatility: The Case of the New EU Members," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 57(9-10), pages 414-432, October.
  5. Lucjan Orlowski & Krzyzstof Rybinski, 2005. "Implications of ERM2 for Poland’s Monetary Policy," William Davidson Institute Working Papers Series wp802, William Davidson Institute at the University of Michigan.
  6. Tigran Poghosyan & Evzen Kocenda, 2006. "Foreign Exchange Risk Premium Determinants: Case of Armenia," William Davidson Institute Working Papers Series wp811, William Davidson Institute at the University of Michigan.
  7. Ryan Ratcliff, 2010. "Predicting nominal exchange rate movements using skewness information from options prices," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 15(1), pages 75-92.

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