Financial and Monetary Integration in the New Europe
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Financial and Monetary Integration in the New Europe

Convergence Between the EU and Central and Eastern Europe

Edited by David G. Dickinson and Andrew W. Mullineux

Potential new entrants to the European Union from Central and Eastern European countries face many challenges to achieve financial convergence with the existing EU nations. Using detailed case studies from Bulgaria, the Czech Republic, Latvia, Lithuania and Poland and analysis of cross country data from these regions, Financial and Monetary Integration in the New Europe looks at the key issues for applicant countries as they negotiate the terms of their membership in the European Union. Of major concern to these countries is the financial sector and its implications for economic growth and the conduct of macroeconomic policy. The book examines, in particular, monetary and exchange rate policies, banking regulation and financial market efficiency. The overall impact of building a market driven financial system on economic development is also explored.
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Chapter 5: Interest rate policy and inflation behaviour in the Czech Republic: from exchange rate to inflation targeting

Eric Girardin and Nicholas Horsewood

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5. Interest rate policy and inflation behaviour in the Czech Republic: from exchange rate to inflation targeting Eric Girardin and Nicholas Horsewood INTRODUCTION After the speculative attacks which hit the Czech koruna in spring 1997, the Czech monetary authorities abandoned exchange rate targeting in favour of inflation targeting towards the end of 1997. Given the change of focus of economic policy, it is useful to try to isolate the arguments of the interest rate reaction function of the Czech monetary authorities in the former period and determine to what extent they changed in the subsequent period. One needs to evaluate the success of the inflation targeting strategy by examining its impact on inflation forecasts and on the dynamics of the inflation process. Previous work, which examined the experience ÿ of inflation targeting in the Czech Republic (Mahadeva and Sm’dkov‡ 1998), relied on a calibrated model. We rather favour here an econometric approach that may look somewhat tentative given the short span of data available. However, we manage to partially side step this limitation by using monthly data, with the key series displaying considerable variability. In the next section of this chapter we review briefly the experience of the Czech Republic with the search for a nominal anchor, relying initially on exchange rate targeting and switching to inflation targeting some time after the collapse of the target zone. The following section provides estimates of the interest rate reaction function of the Czech National Bank (CNB) over the two regimes. Then, we offer...

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