The European Monetary Union as a Commitment Device for New EU Member States

Federico Ravenna

Working Papers from Oesterreichische Nationalbank (Austrian Central Bank)

Abstract: We show that the credibility gain from permanently committing to a fixed exchange rate by joining the European Monetary Union can outweigh the loss from giving up independent monetary policy if the domestic monetary authority does not enjoy full credibility. Using a DSGE model, this paper shows that when the central bank enjoys only limited credibility a pegged exchange rate regime yields a lower loss compared to an inflation targeting policy, even if this policy ranking would be reversed in a full-credibility environment. There exists an initial stock of credibility that must be achieved for a policy-maker to adopt inflation targeting over a strict exchange rate targeting regime. Full credibility is not a precondition, but exposure to foreign and financial shocks and high steady state inflation make joining the EMU relatively more attractive for a given level of credibility. The theoretical results are consistent with empirical evidence we provide on the relationship between credibility and monetary regimes using a Bank of England survey of 81 central banks.

Keywords: Inflation targeting; Credibilty; Open Economy; Exchange Rate Regimes; Monetary Policy (search for similar items in EconPapers)
JEL-codes: E31 E52 F02 F41 (search for similar items in EconPapers)
Pages: 52
Date: 2005-05-12
New Economics Papers: this item is included in nep-eec, nep-ifn, nep-mac and nep-mon
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Working Paper: The European Monetary Union as a commitment device for new EU member states (2005)
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