Monetary regime choice in the accession countries - a theoretical analysis

This paper studies the choice of the monetary regime in a small open economy with special focus on the EMU accession countries. In the framework of a two - country DSGE model we conduct policy experiments consisting in analysing the effects of different monetary regimes (roughly representing the current choices of the accession countries) on the dynamics and volatility of an accession economy. We study the real exchange rate determination in the long run and the short run as it summarises the pattern of the stabilisation of an accession economy in response to the shocks. Our benchmark analysis indicates that the managed float regime can attain the lowest consumption gap and at the same time guarantee the moderate changes in the nominal interest rate, nominal exchange rate and inflation. However parameters summarising its sensitivity to nominal exchange rate movements and inflation pressures depend on the underlying shocks. Additionally the sensitivity analysis indicates that choice of the monetary regime is dependent also on the specific structure of a small open economy. In particular a small share of nontradables, a high degree of openness and the high pass through are advocates for the managed regimes frequently observed in the accession countries.