Table Of ContentINCLUSION OF CENTRAL EUROPEAN COUNTRIES
IN THE EUROPEAN MONETARY UNION
INCLUSION OF CENTRAL EUROPEAN
COUNTRIES IN THE EUROPEAN
MONETARY UNION
Edited by
Paul De Grauwe
UniversUy ofL euven
Vladimir Lavrac
Institute for Econotnic Research. Ljubljana
SPRINGER SCIENCE+BUSINESS MEDIA, B.V.
A C.I.P. Catalogue record for this book is available from the Library of Congress.
ISBN 978-1-4613-7307-0 ISBN 978-1-4615-5073-0 (eBook)
DOI 10.1007/978-1-4615-5073-0
Printed on acid-free paper
AlI Rights Reserved
il) 1999 Springer Science+Business Media Dordrecht
Originally published by Kluwer Academic Publishers in 1999
Softcover reprint of the hardcover 1s t edition 1999
No pact of the material protected by this copyright notice may be reproduced or
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Contents
Contributing Authors ................................................................................................ vii
Abbreviations ............................................................................................................ ix
Preface ....................................................................................................................... xi
Chapter 1: ................................................................................................................... 1
Introduction
Challenges ofE uropean Monetary Union for Central European Countries
Paul De Grauwe and Vladimir Lavrac
Chapter 2: ................................................................................................................. 13
Are Central European Countries Part oft he European
Optimum Currency Area?
Paul De Grauwe and Yunus Ah'oy
Chapter 3: ................................................................................................................. 37
Slovenian and European Trade Structures
Daniel Gros and Guy Vandille
Chapter 4: ................................................................................................................. 53
Fiscal Consolidation in the Central European Countries
and European Monetary Union
Paul De Grauwe and Vladimir Lavrac
Chapter 5: ................................................................................................................. 63
Exchange Rate Policy of Central European Countries in the Transition
to European Monetary Union
Giuseppe Tullio
Chapter 6: ............................................................................................................... 105
Inclusion of Central European Countries in the European
Monetary Integration Process
Vladimir Lavrac
Chapter 7: ............................................................................................................... 119
Integrating Central and Eastern Europe into the European Union:
The Monetary Dimension
Peter Backe
Chapter 8: ............................................................................................................... 141
Echoing the European Monetary Integration in the Czech Republic
Oldrich Dedek
Chapter 9: ............................................................................................................... 183
Monetary Arrangements and Exchange Rate Regime in a Small
Transitional Economy (Slovenia)
Ivan Ribnikar
Index ....................................................................................................................... 219
v
Contributing Authors
YunusAksoy
University of Leuven
Peter Backe
Osterreichische Nationalbank, Vienna
Oldrich Dedek
Czech National Bank, Prague
Paul De Grauwe
University of Leuven
Daniel Gros
Center for Economic Policy Studies, Brussels
Vladimir Lavrai!
Institute for Economic Research, Ljubljana
Ivan Ribnikar
University of Ljubljana
Giuseppe Tullio
University of Brescia
Guy Vandille
University of Leuven
vii
Abbreviations
BIS ........................... Bank for International Settlements
BLEU. ...................... Belgium-Luxembourg Economic Union
BoS .......................... Bank of Slovenia
CAP ......................... Common Agricultural Policy
CE countries ............ Central European countries
CEE countries .......... Central and Eastern European countries
CEFTA ................... Central European Free Trade Agreement
CMEA ..................... Council of Mutual Economic Aid
CNB ......................... Czech National Bank
EBRD ...................... European Bank for Reconstruction and Development
ECB ......................... European Central Bank
ECU ......................... European Currency Unit
EFTA ....................... European Free Trade Area
EMS ......................... European Monetary System
EMU ....................... European Economic and Monetary Union
ERM ....................... Exchange Rate Mechanism
ERM II ..................... Exchange Rate Mechanism 2
ESCB ....................... European System of Central Banks
EU. ........................... European Union
GDP ......................... Gross Domestic Product
IMF .......................... International Monetary Fund
IFS ........................... International Financial Statistics
ILO .......................... International Labour Organisation
NAFTA .................... North Atlantic Free Trade Area
NATO ...................... North Atlantic Treaty Organisation
NCBs ....................... National Central Banks
OCA ........................ Optimum Currency Area
OECD ...................... Organisation for Economic Co-operation and Development
PPP .......................... Purchasing Power Parity
SITC ....................... Standard International Trade Classification
TEU ......................... Treaty on European Union
VAT ......................... Value-Added Tax
ix
Preface
The creation of the European Economic and Monetary Union (EMU) and
the introduction of the euro is a historical event for the EU countries. The
debates on the desirability of the EMU provoked a vast economic literature
dealing with the theory of the optimum currency area, costs and benefits of
the EMU, symmetric vs. asymmetric shocks, alternative mechanisms of
adjustment in a monetary union and so forth. Until recently, for the Central
European candidate countries for a full membership in the EU, these issues
seemed to be too far away, as they concentrated on devising their own
monetary and exchange rate systems suitable for their transition period. The
challenges of the EMU for the Central European countries were practically
not dealt with in both Western and Eastern economic literature. The present
book aims to fill this gap, by focusing on the most direct issue of relevance
for the Central European countries with respect to the EMU -why, how and
when these countries are expected to join the EMU. The papers included in
this volume study the relationship between the EU accession process of the
Central European candidate countries and their involvement in the process of
European monetary integration. The book focuses on two main issues: First,
are these countries (now or possibly later) a part of the European optimum
currency area, so that they should belong to the euro area in the near future?
Second, if so, how and when should they undertake necessary adjustments in
their monetary and exchange rate policies and join the ERM 2 and the EMU?
This book contains the collection of working papers resulting from the
research project "Inclusion of Central European Countries in the European
Monetary Integration Process", which were presented at two workshops in
Leuven in February 1997 and in Ljubljana in September 1997. This research
project was financed by the European Commission through its ACE-Phare
research programme. We would like to thank the European Commission for
its financial support, which gave us a valuable opportunity to establish
research links and exchange expertise between Western and Central
European economists involved in the research on monetary integration in
Europe. Finally, we would like to express our thanks to all those who in
various ways contributed to this volume in its final form.
Paul de Grauwe and Vladimir Lavrac
xi
Chapter 1
Introduction
Challenges of European Monetary Union for Central
European Countries
PAUL DE GRAUWE AND VLADIMIR LAV RAC
The creation of the European economic and monetary union (EMU) and
the introduction of the European single currency, the euro, is a historic event,
which will lead to fundamental changes in the EU economies. These changes
will undoubtedly have a significant impact on the economies of the Central
European countries, candidates for a full membership in the EU, similarly as
the preparations of the EU countries for the EMU and their efforts to meet
the Maastricht convergence criteria have already affected the Central
European economies. Decision-makers at various levels (governments,
enterprises, banks) will have to adapt to the changing environment, first by
adjusting to the irrevocably fixed exchange rates among the EU currencies
participating in the EMU and then by adjusting to the introduction of the
euro and to the elimination of national currencies in the euro zone. The
present volume, however, does not concentrate on these otherwise important
issues of the impact of the EMU on the Central European countries. It
focuses primarily on the most direct questions related to the EMU for these
countries -why, how and when the Central European EU candidate countries
will join the EMU.
The group of Central European countries under consideration includes
the Czech Republic, Hungary, Poland and Slovenia. They (together with
Estonia and Cyprus) belong to the group of countries which started official
negotiations for a full membership in the EU in March 1998. In some cases,
Slovakia is also included in the analysis, as it geographically belongs to the
same group and as it is a member of the CEFTA (Central European Free
Trade Agreement). It should be mentioned at the outset that this group of
1
2 Paul De Grauwe and Vladimir Lavrac
countries is rather homogenous as regards the fulfilment of the Maastricht
convergence criteria. In general, they fulfil both fiscal criteria (fiscal deficit,
public debt), but fail to meet the three monetary convergence criteria
(inflation rate, long-term interest rate, stability of the exchange rate). The
Czech Republic and Slovenia, where the inflation rate has stabilised in the
high single-digit figures, perform better than Hungary and Poland in terms of
both fiscal and monetary Maastricht criteria. While the analysis in this book
covers the entire group of the Central European countries, special attention is
given to the Czech Republic and Slovenia, as these two countries are the
most advanced within the group in terms of their per capita GDP and their
readiness to join the European monetary integration process. The book
includes the case studies of these two countries on their way towards joining
the EMU.
In the period of transition individual Central European countries have
chosen very different and completely uncoordinated monetary and exchange
rate systems and policies. The exchange rate regimes of these countries
cover the whole spectrum of possible solutions: Slovenia decided for a
(managed) floating exchange rate system, the Czech Republic used a fixed
exchange rate system until recently, when it switched to a floating regime.
Poland and Hungary opted for some interim solutions. Poland first decided
for a fixed, but adjustable peg system, while now it practices a crawling peg
regime, which is also in use in Hungary. Membership of these countries in
the CEFTA has remained an unused opportunity to harmonise their
monetary and exchange rate policies. Their association agreements with the
EU do not restrain their monetary and exchange rate autonomy either.
However, it can be expected that in their EU accession period and in the
negotiations for a full membership in the EU, the Central European countries
will be subject to some pressures and obligations for the co-ordination and
harmonisation of their monetary and exchange rate systems and policies,
with the aim of better preparing them for their future inclusion in the ERM 2
(Exchange Rate Mechanism 2) and in the EMU.
For the moment the Central European countries are not included in any
form of the European monetary integration. They enjoy their full monetary
sovereignty, with their own currency, their central bank and autonomous
monetary and exchange rate policies.
Obligations and opportunities related to the European monetary
integration derive from the prospective membership of the Central European
countries in the EU. In principle, member countries of the EU are included in
the European monetary institutions, such as the EMS (European Monetary
System) and the EMU. However, at least until now it could be observed that
the inclusion in the European monetary integration process did not occur at
the same pace. Greece became member of the ERM only in March 1998, and
Inclusion ofC entral European Countries in the European 3
Monetary Union
some of the other EU member countries did not join the ERM until they
were monetarily mature enough. It should be mentioned that they joined the
ERM at their own will and they were able to leave the ERM when they
found its requirements too constraining (Great Britain, Italy). In the case of
the EMU, the opt-out countries (Great Britain, Denmark) decided not to
participate in the third stage of EMU in 1999.
Until the Central European countries join the EU, they can not formally
and institutionally enter its mechanisms of monetary integration.
Membership in the EMS, in the ERM 2 and in the EMU is open only to EU
members. The Central European countries can therefore for the moment only
unilaterally, informally and functionally adjust to the mechanisms of the
European monetary integration. In the transitional period they can shadow
the euro, with the aim of better preparing themselves for the future inclusion
in the ERM 2 and in the EMU. If we take the case of Slovenia, which uses a
floating exchange rate system, it could (after bringing its inflation rate down
to the level near to the EU inflation rate) make a switch to a system of fixed
but adjustable exchange rate in line with the requirements of ERM 2.
The Central European countries could go even further in their unilateral
adaptations to the prerequisites of the European monetary integration by
irrevocably fixing the exchange rate. They could peg their currencies to the
eurQ, when this opportunity opens in 1999. In this case they commit
themselves to a de facto monetary union with the monetary area of the euro.
This would lead to the loss of their monetary sovereignty, as their monetary
policy would be directed towards sustaining the fixed exchange rate. The
problem of unilateral de facto monetary unions is that the country involved
bears all the costs (loss of the monetary sovereignty), while it participates in
only some of the benefits of the monetary union. Additionally, such a
unilateral commitment to the irrevocable fixing of the exchange rate would
lack credibility compared to a formalised monetary union.
In this book, the focus is primarily on the other alternative - the formal
and institutional inclusion of the Central European countries in the European
monetary integration process. This process is closely related to the accession
of the Central European countries in the EU. This link between membership
in the EU and in EMU is not always correctly appreciated in the candidate
countries. This could be due to the fact that some EU countries were in a
position to decide whether or not to join EMU. It is unlikely that this option
will exist for the Central European countries. Criteria for the EU accession,
which were formulated at the Copenhagen Summit in 1993, include, among
others, the capacity of a candidate country to take up all obligations from the
EU membership (acquis communautaire), including the adherence to the
aims of political, economic and monetary union. In practice this means that a
