Abstract
This paper explores the impact of the USD/EUR exchange rate on inflation in the Central and East European countries (CEEC). In particular, we analyse which portion of the variation in inflation in the CEEC can be attributed to the USD/EUR exchange rate, as an external shock. In addition, we study to what extent USD/EUR exchange rate shocks influence inflation in the CEEC. A vector autoregression model with block exogeneity restrictions is employed to trace the impact of the USD/EUR exchange rate fluctuations on inflation at each stage along the distribution chain. We find that the USD/EUR exchange rate has different levels of impact on inflation among the CEEC with different exchange rate regimes. Our empirical exercise shows that the USD/EUR exchange rate accounts for the largest share of inflation volatility in the CEEC with stable exchange rates of the domestic currency against the euro. Furthermore, the extent of the USD/EUR exchange rate's influence on inflation in the CEEC is the largest in the economies with stable exchange rate regimes. These results might be important in the context of the price stability requirement of the Maastricht Criteria: in addition to the internal challenge of keeping low inflation and dealing with the difficulties of the price convergence process, the applicant countries could face problems beyond their influence.
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