Exchange rate arrangements in the accession to the EMU

After accession to the European Union, new member countries have to decide the optimal path to the adoption of the euro. Some have argued that the euro should be adopted only when a sufficient degree of real convergence has been achieved. The idea is that real exchange rates will be affected by a real appreciation trend, which would imply higher inflation when countries enter the euro zone. This paper shows that Balassa-Samuelson effects are relevant, but such long-term considerations cannot justify maintaining flexibility of exchange rates for a long time. Another set of arguments in favour of delaying adoption of the euro is based on shorter-term considerations, namely the possibility of using nominal exchange rates to achieve a real exchange rate target and maintain competitiveness. However, this policy of real exchange rate targeting is likely to induce higher and more persistent inflation rates. This paper finds that the arguments in favour of flexibility of exchange rate and delay in the adoption of the euro are rather weak, and therefore a fast adoption of the Euro should be considered. (Comparative Economic Studies / SWP)