THE RISK OF LOSING CONTROL OF REAL INTEREST RATE LEVEL IN THE CURRENCY BOARD REGIME

Abstract

The chapter analyses how the implementation of currency board regimes affected Baltic states' prospects to join the euro zone. Not long ago it was expected that the currency board regime would enable Baltic States to quickly join into the Euro zone, i.e. two years after their accession to the EU. Such a scenario seemed almost certain. The recent prospects of joining the Euro zone by Baltic states seem to be distant and uncertain. The main reason for this dramatic change was the materialisation of risks, which are inherent to the currency board regime. Above all, the system is highly procyclical. The illustration is the negative feedback between the credit boom and the fall in real interest rates. Baltic states are facing not only the problem how to fulfill the Maastricht inflation criterion, but also the problem how to avoid a financial crisis, which might be triggered by the rapid growth of their foreign indebtedness.