slovakia was 5. 6 %, significantly above the average economic growth in the euro area. this resulted in real economic convergence as the gdp per inhabitant in purchasing power parity terms as a percentage of the gdp per inhabitant of the “ euro area ” increased from below 44 % in 2000 to above 62 % in 2007. the good times for the slovak economy are exemplified by rising real incomes. importantly, the gains in prosperity have also spread beyond the country ’ s economic heart in bratislava, even though considerable disparities between regions still exist. slovakia has experienced only limited external economic imbalances in recent years. the current account deficit remained relatively contained in the past few years and, due to increasing export capacities, it has in fact been shrinking lately. unit labour costs have until recently favoured the competitiveness of slovak producers. the koruna has participated in the exchange rate mechanism ii since november 2005. the underlying strong macroeconomic performance has led to a gradual appreciation of the nominal exchange rate against the euro, without impairing the competitiveness of slovak exporters. reflecting strong macroeconomic fundamentals, the central parity of the slovak koruna against the euro was revalued by 8. 5 % and 17. 65 % in march 2007 and may 2008, respectively. economic progress in slovakia has been based on a series of structural reforms. the substantial reforms of taxes and social benefits together with a greater flexibility in product and labour markets have brought slovakia to the attention of foreign investors. the ensuing inflow of foreign direct investment has boosted the economy and promoted rapid real gdp growth. and these days, more than ever, the pace of reforms from earlier years has to be maintained in order to reap all the benefits of euro adoption. 2. sustainable convergence is key euro adoption by slovakia implies that the benefits of the single market will be further enhanced by the single currency. the euro offers a credible framework for price stability as it removes exchange rate uncertainty within the euro area. slovakia will benefit from the stability - oriented policy of the ecb, which will help to anchor inflation expectations. furthermore, euro adoption may help to shield slovakia, a small and highly open economy, against the effects of international financial turbulence, which often has disproportionate effects on smaller economies. however, for the euro to remain a success story in slovakia, the national authorities will need to be very alert and pursue ambitious economic policies on all fronts. our main concern is that slovakia, being a catching - up economy

the choice of a specific path can be used to support broader purposes, without prejudicing the outlook for price stability over the medium term. this has been recognised by the so - called flexible inflation targeting literature. 10 this framework explicitly foresees the use of monetary policy to smooth developments in economic activity over the business cycle, while anchoring longer - term inflation expectations at levels consistent with price stability. in principle, the flexibility accorded to policy - makers by the medium - term orientation of monetary policy could be used in other directions, such as to contain financial imbalances or limit asset price volatility. the feasibility and desirability of such alternative approaches rests crucially on how monetary policy actions are perceived to be transmitted to the economy in general, and the price level in particular – in other words, on the perception of the structure of the economy and the monetary policy transmission mechanism. 2. the monetary policy transmission mechanism the desirability of flexible inflation targeting was established using the canonical new keynesian model. in its simplest version, welfare is maximised by fully stabilising inflation at its target level, a policy which simultaneously delivers a zero output gap. 11 this so - called “ divine coincidence ” 12 implies that policy - makers who care only about stabilising inflation will deliver an efficient path of economic activity. and, symmetrically, policy - makers who focus solely on keeping output at an ( appropriately defined ) potential level will deliver low and stable inflation rates. a relatively simple taylor - like monetary policy rule could achieve these desirable outcomes. in this benign world, traditional monetary policy trade - offs appear to have disappeared! see m. a. king ( 1997 ), “ changes in uk monetary policy : rules and discretion in practice ”. journal of monetary economics 39, pp. 81 – 97. see l. e. o. svennson ( 1998 ), “ inflation targeting in an open economy : strict or flexible inflation targeting? ” victoria economic commentaries 15 ( 1 ). at least when the output gap is defined in a “ model - consistent ” manner, i. e. as deviations of output from the level it would achieve in the absence of nominal rigidities. see : o. blanchard and j. gali ( 2007 ). “ real wage rigidities and the new keynesian model ”, journal of money, credit and banking 39 ( s1 ), pp. 35 – 65. it is widely recognised that even modest deviations from the simplest version of