Control of inflation on the road to the European Monetary Union : the case of Slovenia

Abstract

This paper analyzes the monetary policy of Slovenia on the path to euro adoption. Analysis of the exchange rate pass-through effect supports the link between the practice of real exchange rate targeting within the managed float regime and inflationary developments. With a counterfactual policy experiment in a cointegrating vector autoregressive (VAR) model, it is shown that stabilizing the nominal exchange rate and entering into the European Exchange Rate Mechanism (ERM II) sustainably reduced inflation to a level compatible with the Maastricht criteria, without creating any significant imbalances in the economy. For this reason, it can be expected that the stabilizing effects of exchange rate stability will continue under the European Monetary Union (EMU).