Working Paper: CEPR ID: DP1720
Authors: F Gulcin Ozkan; Anne Sibert; Alan Sutherland
Abstract: This paper models the behaviour of a potential entrant into a monetary union where there is an inflation entry condition. In addition to making a monetary policy decision during a qualifying period, the potential entrant must make a decision about structural reform. The paper shows that the entry condition can have two undesirable effects. First, it can lead to multiple equilibria because inflationary expectations acquire a self-fulfilling property. Second, the entry condition can lead to a reduction in the amount of reform. This is because the entry condition reduces inflationary expectations and thus reduces the incentive to reform.
Keywords: monetary union; convergence; entry conditions
JEL Codes: F33; F36
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Entry condition (Y20) | multiple equilibria (D50) |
| Self-fulfilling inflationary expectations (E31) | compliance (K40) |
| Lower inflation expectations (E31) | compliance (K40) |
| Higher inflation expectations (E31) | compliance (K40) |
| Tighter entry condition (C62) | lower inflationary expectations (E31) |
| Lower inflationary expectations (E31) | reduction in structural reform (E69) |
| Entry condition (Y20) | reduction in structural reform (E69) |