2 Real Convergence and Euro Adoption in Central and Eastern Europe: Trade and Business Cycle Correlations as Endogenous Criteria for Joining the EMU


Ten countries acceded to the European Union (EU) in 2004, including five in Central Europe and the three Baltic republics (along with Cyprus and Malta). Should they also join the European Monetary Union (EMU), as envisioned in the Maastricht Treaty? The advantages of belonging to such a currency area are fairly straightforward. They include most notably the promotion of trade and growth. The disadvantages are a bit more complicated but include most notably the loss of the ability to pursue an independent monetary policy.1 What would it take for the advantages to outweigh the disadvantages? The well-known theory of optimum currency areas weighs the advantages of fixed exchange rates against the advantages of floating.2 One standard textbook criterion is a particular kind of convergence of the candidate economy to the economy of the euro area: a synchronization of the business cycle or what is called in the jargon “symmetry of shocks.”3 If the candidate country experiences economic downturns when and only when the rest of the EMU experiences economic downturns, it will not be giving up much to allow its monetary policy to be set in Frankfurt. The interest rates that suit the rest of the EMU are likely to suit the candidate country as well. If cyclical correlation is low, on the other hand, having to accept the interest rate constraint is more likely to be a hardship.