1 Exchange Rate Stability, Inflation and Growth in (South) Eastern and Central Europe*

This paper analyzes the impact of the exchange rate regime on inflation and output in South East-ern and Central Europe. The panel estimations for the period between 1994 and 2004 show that de facto measures of exchange rate stability have a better explanatory power than the de jure measures in the inflation and growth equations. For the whole observation period the estimations reveal a significant impact of exchange rate stability on low inflation as well as a highly signifi-cant positive impact of exchange stability on real growth. When sub-dividing the period into a “high-inflation ” period (1994-1997) and a “low inflation period ” (1998-2004) and when remov-ing outliers from the sample, the evidence in favour of a positive association between exchange rate stability and inflation disappears. The association of exchange rate stability with higher real growth remains robust. These findings suggest that that membership of the (South) Eastern and Central European countries in the European Monetary Union would have a positive impact on these countries ’ growth rates