Why the Maastricht inflation criterion has become harder to satisfy

The ECB seems to be getting things right these days. The inflation rate in the eurozone is stable even in the current situation with exploding energy prices and the eurozone economies picking up. Slovenia entered the Economic and Monetary Union (EMU) in January this year, and Malta and Cyprus are following suit on the first of January next year. The other countries that joined the EU in 2004 and 2007 are, however, still in the waiting room and may stay there for a while. For most of these countries the problem is that they do not satisfy the inflation criterion of the Maastricht Treaty.

The irony is that for the countries waiting to join the eurozone, the recent expansions of the EU have made it harder to satisfy the inflation criterion. This piece summarises some recent research seeking to quantify the effect on the inflation reference value of 12 new countries having joined the EU within the last 3 years. For further reading I refer to my joint working paper with John Lewis: “The Maastricht inflation criterion: What is the effect of expansion of the European Union?, http://www.dnb.nl/dnb/home/file/Working%20Paper%20No%20151-2007_tcm47-164976.pdf.

The inflation criterion of the Maastricht Treaty says that to join the EMU a country must have an inflation rate lower than or equal to a reference value defined as the average inflation rate in the three EU countries with the best performance in terms of price stability, plus 1.5 percentage points. The reference group of the three best performing countries has been taken to comprise the three EU countries with the lowest non-negative inflation, so that countries with negative inflation are excluded from the reference group, although this procedure may not necessarily be employed in all future convergence assessments. 

The impact of the expansions of the EU can be assessed via a counterfactual experiment using monthly inflation data since 1999. Comparing the inflation reference value with respectively 15 and 27 EU members, it follows that if the EU had comprised 27 Member States instead of 15, the reference value would have been substantially lower (up to 0.5 percentage points) in relatively long periods since 1999. The analysis also shows that the inflation reference value fluctuates considerably from month to month as countries with inflation around zero shift in and out of the reference group. 

An alternative methodology is to use Monte Carlo simulations to ascertain the distribution of the inflation reference value for different sets of EU countries. The inflation distributions and their parameters can be derived from previous inflation data or be based “expert assessments”. The figure below shows the distributions of the inflation reference value (in the baseline scenario) with 15 and 27 EU countries, respectively.


The simulations show that the distribution of the inflation reference value shifts to the left after the increase of the number of EU members from 15 to 27. The expected reference value has decreased by 0.15–0.2 percentage points depending on the specific assumptions employed. There is around a 25 percent change that the gap is 0.3 percentage points or larger. The relatively large standard deviation of the reference value is a result of the exclusion of countries with negative inflation from the reference group.

The treatment of countries with negative inflation in the calculation of the reference value has a large impact on the results. The simulations suggest, for instance, that if countries with negative inflation are retained in the reference group, the average reference value is likely to be around 0.5 %-points lower with 27 EU countries than with 15 EU countries.

The analysis summarised above shows that it has become somewhat harder to join the eurozone now than it was in 1998 when the first round of countries were admitted to the EMU. With the current relatively high inflation rates in the Baltics, Hungary and Bulgaria, a lowering of the reference value by 0.2 %-points is without importance for the prospect of these countries shortly joining the EMU. Inflation rates, however, can change rapidly, and a 0.2%-point lowering of the reference value can then be enough to keep these countries out of the EMU.

3 Responses to "Why the Maastricht inflation criterion has become harder to satisfy"

  1. Guest   December 4, 2007 at 7:14 am

    Thanks for your post.Given EU newcomers’ difficulties in meeting the Maastricht Treaty inflation criteria and the current global environment of rising food and oil prices, what are you feelings about the likelihood of EU newcomers – ex. the Baltics, Bulgaria, Romania, Czech Republic, Hungary, Poland – meeting the criteria within the next 5-10 years? If these countries don’t manage to meet the Maastricht criteria in the next few years, do you think they might abandon hopes of joining the Eurozone altogether?

  2. Karsten Staehr   December 4, 2007 at 2:05 pm

    To Guest: Yes, I believe that several, if not all, of the new EU countries will join the EMU within a relatively short time horizon. There is, however, a bit of a paradox here. The Baltic States and Bulgaria maintain fixed pegs against the euro and thus effectively already share the monetary policy of the eurozone. Interest rates in these countries follow the ECB’s interest rate very closely. These countries, however, also have relatively high inflation as high productivity increases in the tradable sector lead to high wage growth and consequently high inflation in the non-tradable sector. Poland, the Czech Republic and Slovakia have floating exchange rates, but have seen their currencies appreciate against the euro and have therefore been able to keep inflation rates low. The paradox is thus that the countries that currently are the closest to the eurozone encounter the most problems satisfying the Maastricht inflation criterion, while several of the countries with independent monetary policy and diverging exchange rates have few problems satisfying the criterion. No, I do not think that the new EU countries will “abandon hopes of joining the Eurozone altogether”. First, as part of the Copenhagen criteria for accession to the EU, the countries are obliged to seek membership of the EMU. This obligation can be ignored for a long time (as demonstrated by Sweden), but it remains as the countries have not opted out of the EMU. Second, for the Baltic States and Bulgaria full membership of the eurozone would change very little except that the last remaining exchange rate risk would be eliminated. And who would not like to get rid of exchange rate risks? Third, by joining the eurozone the new EU countries would put a political problem behind them and be able to concentrate their political and administrative resources on other issues. Fourth, perhaps we should not forget that the theory of currency unions suggest that small, open and trade-dependent economies stand to benefit the most from joining a currency union; the new EU countries indeed have small, open and trade-dependent economies.