Entry rates and the risks of misalignment in the EU8

New member states will join the EMU in the coming years. Setting the central parity at which they will join has been and will be a challenging task, as there is a considerable amount of uncertainty, both from a theoretical and an empirical perspective, surrounding the determination of the optimal exchange rate. Given the probable difficulty in evaluating the equilibrium rate it is thus advisable to focus on the effects of a misalignment of the entry rate for the economy, as it has implications for countries' real and nominal convergence. An overvalued exchange rate would have an adverse impact on a country's competitiveness and its growth, while an undervalued currency would contribute to an overheating of the economy and an excessive inflation. The objective of this paper is to better understand the role of the entry rates for short run inflation and GDP developments and their implications for the inflation criterion and the real convergence process. Having estimated equilibrium exchange rates for eight out of ten countries that entered the EU in May 2004: Czech Republic, Estonia, Hungary, Lithuania, Latvia, Poland, Slovenia and Slovakia we conduct simulations showing what their adjustments to equilibrium would be if their entry rates deviated from the optimal ones.