Inflation convergence in the euro area: just another gimmick?

Ales Bulir and Jaromir Hurnik

Journal of Financial Economic Policy, 2009, vol. 1, issue 4, 355-369

Abstract: Purpose - The Maastricht inflation criterion has influenced the choice of disinflation strategies of prospective euro area member countries. Some historically high‐inflation countries chose the fiat disinflation strategy of “low inflation now, reforms later,” bringing inflation down quickly. Their inflation rates increased immediately after their euro applications were assessed positively and stayed significantly higher than inflation in France and Germany, two historically low‐inflation countries. The inflation differentials reflect both structural rigidities inherited from the past and higher inflation expectations stemming from the chosen disinflation strategy. This paper seeks to address these issues. Design/methodology/approach - The paper highlights the inflation consequences of the choice of compliance policies with the Maastricht inflation criterion. To this end, the paper estimates costs of future disinflations in six high‐inflation countries for which well‐established stylized facts are held. Findings - The Maastricht inflation criterion has been an influential nominal rule. While it swayed the public stance toward low inflation, it biased the choice of the disinflation strategy toward fiat measures. Inflation in these countries declined only temporarily, giving these countries a pronouncedV‐shaped pattern of inflation. These countries tended to opt for “low inflation now, reforms later” approach, which yielded low inflation quickly at the cost of postponing long‐term structural reforms. While the ERM II process can be made relatively painless by fiat measures, such a strategy results in inefficient transmission mechanisms and costly disinflations. Originality/value - The paper highlights the long‐run inflation consequences of the choice of compliance policies with the Maastricht inflation criterion. While inflation was low prior to the euro and stayed low afterward in inflation‐averse countries, aV‐shaped inflation path in high‐inflation countries is seen. The countries that expect to benefit the most from a fast adoption of the euro are likely to opt for fiat‐driven compliance. The choice of compliance policies has consequences for future disinflations – monetary transmission distortions and inefficiencies of fiat policies increase the cost of future disinflations and will complicate ECB policymaking for years to come.

Keywords: Inflation; Economic convergence; Euro; European Union (search for similar items in EconPapers)
Date: 2009
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Persistent link: https://EconPapers.repec.org/RePEc:eme:jfeppp:v:1:y:2009:i:4:p:355-369

DOI: 10.1108/17576380911050070

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