Tuesday, May 02, 2006

Re: Exchange rate regimes in selected Transition Economies

I will reflect on the posting of different exchange rate regimes in the CEECs. In the literature, the exchange rate regime is a mirror image of the monetary regime since central banks can either try to control the exchange rate or inflation, but not both at the same time.
In the late nineties inflation targeting monetary regime was adopted explicitly in three new European Union countries: the Czech Republic in 1997, Poland in 1998 and Hungary in 1998, while Slovakia was also implicitly an inflation targeter from 1999.
Since inflation in these countries in the first years of the regime was higher than the Maastricht inflation criterion, some questioned its suitability and favoured fixing the exchange rate instead and preferred the currency board arrangements.
Inflation targeting regime indeed has some negative features: the targets are difficult to specify and actual inflation in the new entrants to the EU was comparatively unstable relative to the long-term inflation trend. On the other hand, the inflation targeting regime enables the country to focus on domestic shocks, while the fixed exchange rate can not. Therefore it enables the central bank to focus on domestic supply and demand disequilibrium, which could be harmful to the economy. In addition, inflation targeting is easily understood by the public and thus highly transparent.
The inflation targeting regime could be seen as an option for countries with recent high inflation like Bulgaria and Romania or as a viable alternative to currency board (Lithuania and Estonia) or hard peg (Latvia) monetary strategies for EMU accession. Although these monetary regimes were also successful in keeping inflation low, the recent bad performance of two currency bouard countries (Estonia and Lithuania) on their way to the EMU is rising doubt whether to target inflation is a better strategy to pursue.

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