Bayoumi, T., and B. Eichengreen, 1993, “Shocking Aspects of European Monetary Integration,” in F. Torres and F. Giavazzi, eds., Adjustment and Growth in the European Union (New York: Cambridge University Press).
Blejer, M., J. Frenkel, L. Leiderman, and A. Razin, eds., 1997, Optimum Currency Areas: New Analytical and Policy Developments (Washington: IMF),
Calvo, G., R. Sahay, and C. Vegh, 1996, “Capital Flows in Central and Eastern Europe: Evidence and Policy Options,” in G. Calvo, M. Goldstein, and E. Hochreiter, eds., Private Capital Flows to Emerging Markets After the Mexican Crisis (Washington: Institute for International Economics), pp. 57–90.
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)| false Calvo, G., R. Sahay, and C. Vegh, 1996, “ Capital Flows in Central and Eastern Europe: Evidence and Policy Options,” in G. Calvo, M. Goldstein, and E. Hochreiter, eds., Private Capital Flows to Emerging Markets After the Mexican Crisis( Washington: Institute for International Economics), pp. 57– 90.
Calvo, G., 1998, “The Unforgiving Market and the Tequilazo,” in J.M. Fanelli and R. Medhora, eds., Financial Reform in Developing Countries (New York: Macmillan).
Canzoneri, M., J. Valles, and J. Vinals, 1996, “Do Exchange Rates Move to Address International Macroeconomic Imbalances?” CEPR Discussion Paper No. 1498 (London, October).
Chinn, M.D., 1998, “The Usual Suspects? Productivity and Demand Shocks and Asia-Pacific Real Exchange Rates,” ONB Working Paper 31 (Vienna, July 20).
De Grauwe, P., and Y. Aksoy, 1997, “Slovenia and the European Optimum Currency Area” Working Paper, ACE Project on Inclusion of Central European Countries in the European Monetary Union (Leuven, January).
Eichengreen, B., and P. Masson, 1998, Exit Strategies: Policy Options for Countries Seeking Greater Exchange Rate Flexibility, IMF Occasional Paper 168 (Washington).
Eichengreen, B., and M. Mussa, 1998, Capital Account Liberalization: Theoretical and Practical Aspects, IMF Occasional Paper 172 (Washington).
Fabiani, S., A. Locarno, G.P. Oneto, and P. Sestito, 1997, “NAIRU, Incomes Policy, and Inflation,” Banca d’ltalia Workshop on Monetary Policy, Price Stability, and the Structure of Goods and Labor Markets (Perugia, June 27–28)
Fischer, S., R. Sahay, and C. Vegh, 1996, “Stabilization and Growth in Transition Economies,” Journal of Economic Perspectives (Spring), pp. 45–66.
Frankel, J., and A. Rose, 1997, “Endogeneity of the Optimum Currency Area Criteria,” NBER Discussion Paper No. 5700 (New York, August).
Giorgianni, L., 1997, “Foreign Exchange Risk Premium: Does Fiscal Policy Matter? Evidence from Italian Data,” IMF Working Paper WP/97/39 (Washington, March).
Halpern, L., and C. Wyplosz, 1997, “Equilibrium Exchange Rates in Transition Economies,” IMF Staff Papers (December), pp. 405–29.
Helpman, E., L. Leiderman, and G. Bufman, 1994, “A New Breed of Exchange Rate Bands: Chile, Israel, and Mexico,” Economic Policy (October), pp. 260–306.
Hochreiter, E., and G. Winckler, 1995, “The Advantages of Tying Austria’s Hands: The Success of the Hard Currency Strategy,” European Journal of Political Economy, pp. 83–111.
Krajnyak, K., and J. Zettelmeyer, 1998, “Competitiveness in Transition Economies: What Scope for Real Appreciation?” IMF Staff Papers (June), pp. 309–62.
Leiderman, L., and G. Bufman, 1996, “Searching for Nominal Anchors in Shock-Prone Economies in the 1990s: Inflation Targets and Exchange Rate Bands,” in R. Hausman and H. Reisen, eds., Securing Stability and Growth in Latin America (Paris: OECD).
Lipschitz, L., and D. McDonald, 1992, “Real Exchange Rates and Competitiveness: Clarification of Concepts and Some Measurements for Europe,” Empirical Austrian Economic Papers (1), pp. 37–69.
MacDonald, R., 1997, “What Determines Real Exchange Rates? The Long and Short of It” IMF Working Paper WP/97/21 (Washington, January).
Masson, P., 1998, “Monetary and Exchange Rate Policy of Transition Economies After the Launch of EMU,” Fourth Dubrovnik Conference on Transition Economies (Dubrovnik, June 24–26).
McKinnon, R., 1982, “The Order of Economic Liberalization: Lessons from Argentina and Chile,” in K. Brunner and A. Metzler, eds., Economic Policy in a World of Change (Amsterdam: North Holland), pp. 159–86.
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Pujol, T., and M. Griffiths, 1998, “Moderate Inflation in Poland: A Real Story,” in C. Cottarelli and G. Szapary, Moderate Inflation: The Experience of Transition Economies (Washington: IMF and National Bank of Hungary), pp. 197–229.
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Prepared for the Conference on Shaping the New Europe, Vienna Institute for International Economic Studies, November 11–13, 1998. An earlier version was presented at seminars in the Bank of Italy, National Bank of Hungary, and European Commission, on the basis of research undertaken while the author was on sabbatical leave as a visiting professor at the University of Siena. Useful comments were received from conference and seminar participants and Fund colleagues, especially Peter Clark, Hans Flickenschild, Eduard Hochreiter, and Gábor Oblath.
The Copenhagen European Council of June 1993 declared that, in general, the applicant country must have “the ability to take on the obligations of membership, including adherence to the aims of political, economic and monetary union.” Subsequently, however, it was recognized that, “with respect to the aim of economic and monetary union, it is unlikely that the applicants will be able to join the euro area [Stage 3 of EMU] immediately upon accession.” See European Commission (1997, p. 57).
More basically, the acquis implies central bank independence, coordination of macroeconomic policies, prohibition of direct central bank financing of public sector deficits, and privileged access to financial institutions, at the outset, EU membership would be limited to participation in the customs union and the single market, as well as convergence toward, but not participation in, the currency union.
For a recent review of the basic arguments and qualifications in support of this assumption, see the essays, including by Mundell, in Blejer and others (1997). See footnote 6 below for a brief summary of the empirical evidence.
Much empirical analysis, such as in Bayoumi and Eichengreen (1993), based on historical correlations of output changes, arising from demand and supply shocks among EU member countries and among U.S. regions, suggests that a number of EU members in the periphery (as compared with only a few outlying U.S. regions) are prone to suffer destabilizing consequences from the loss of the exchange rate as a policy instrument upon joining EMU currency area. For a recent review of similar evidence, see Calmfors and others (1997). However, Canzoneri, Valles and Viñals (1996) found that past shocks that caused most output variations in the EU do not seem to have resulted in nominal exchange rate fluctuations, while the shocks that explained nominal exchange rate movements are monetary in nature. Overall, the exchange rate seems to have acted as an asset price rather than a shock absorber. The upshot of this study was that EMU will not entail a significant cost in stability for participating EU member countries—with the possible exception of Italy.
Such a situation could arise if, for example, as a result of a downturn caused by recession in a major trading partner economy in transition, the candidate experiences a decline in output growth below its trend GDP yet without entitling it to a waiver (i.e., with less than the threshold 2 percent contraction) under the Pact; see Kopits (forthcoming).
In particular, given constraints to labor mobility, due to the undeveloped housing market and inadequate mass transport.
Estimates of the effect of asymmetric shocks (using alternatively GDP, industrial output and employment as dependent variables) on pooled panel data for EU members and Slovenia, in De Grauwe and Aksoy (1997), indicate that Slovenia does not diverge from Germany, the benchmark country.
This pattern is not surprising given the worldwide trend of declining contribution, first, of agriculture, and then, of industry, to output and employment, during economic development observed in past decades; see IMF (1997, ch. 3).
It may be noted that all candidates have a more advanced and diversified economic structure than the CFA franc zone member countries which automatically participate in Stage 3 of EMU.
The econometric evidence on a large panel of annual country data, in Frankel and Rose (1996), further seems to rule out the hypothesis that increased trade integration can result in greater industry specialization by country and thus to asymmetric industry-specific supply shocks put forth in Krugman (1991).
Trade-weighted average import tariff rates are: 3 percent in Hungary, 6 percent in Poland, and 11 percent in Slovenia. Estimates of average effective rates of protection are 5 percent for Hungary and 7 percent for Slovenia. In Estonia, the nominal and effective rates are near zero. Although difficult to quantify, nontariff barriers have been lowered significantly in all accession countries.
For example, in Hungary, the average annual net cost of sterilization has been measured at nearly 0.2 percent of GDP; see Szapary and Jakab (1998). On the effectiveness of sterilized intervention, recent IMF staff estimates of offset coefficients for the Czech Republic, Hungary and Poland range between -0.4 and -1.
In 1992 and 1993, Poland undertook two one-off devaluations totaling 19 percent, and in 1995, it revalued three times by a cumulative amount of 18 percent.
See the analysis in Obstfeld and Rogoff (1996, Ch. 4), and the estimates for major industrial countries in MacDonald (1997) and for Southeast Asian countries in Chinn (1998). Perhaps the best known corroborating case is that of postwar Japan: the appreciation of the yen (in real terms throughout the period, and in nominal terms since the mid-1970s, following the abandonment of fixed parities) can be largely explained by productivity gains in the tradables sector. Masson (1998) has shown that the trend appreciation attributable to the productivity bias is roughly equivalent to the relative rate of technical progress in the tradables sector multiplied by the share of nontradables in total output.
For an attempt at measuring this effect in economies in transition, see Halpern and Wyplosz (1997) and Krajnyak and Zettelmeyer (1998). For Hungary, Simon and Kovacs (1998) estimated a 3 percent annual rate of appreciation in the long run.
During the transition, major reform in education, health care, pension system, public administration, as well as infrastructure investment in transportation, communications, environmental cleanup and protection, all create conditions for balanced productivity improvements across all sectors. See the distinction drawn between the opposite effects of economy-wide and tradables-based productivity increase in Krugman and Obstfeld (1997, p. 242). However, the net effect of an overall increase in output on nominal exchange rate is ambiguous, depending on whether the output increase raises the real transaction demand for money, pushing down the domestic price level in the long run.
In each country, wage negotiations take place in the first instance under the auspices of a tripartite commission of social partners (constituted by representatives of employers’ associations, organized labor, and government), which sets guidelines for maximum and/or minimum wage increments—usually on the basis of inflation forecasts—that are more or less binding for the private and public sectors. For government employees, wage adjustments are determined in the context of the budget. In the rest of the public sector and private enterprises, an overshoot in the inflation outcome—above the forecast reached under the tripartite agreement—can give rise to upward adjustment even where decentralized bargaining is the dominant form of wage negotiation.
For empirical evidence on the high degree of effective wage indexation (especially in the public sector) in Poland, see Pujol and Griffiths (1998). Wage indexation has been less prevalent in Slovenia. For estimates of wage drift in Hungary, see OECD (1997). In addition, explicit or implicit price indexation in some sectors (e.g., energy in Hungary) may have a similar effect as wage indexation.
See the discussion and simulation results for Italy, allowing for risk aversion, and the United States, without uncertainty, by Clark and Laxton in IMF (1995, annex). Failure to capture this distinction explains the difficulty of estimating an empirically robust relationship between fiscal policy and exchange rate movements.
Such a process has been observed initially in Latin America; see Calvo, Sahay, and Vegh (1996) for the early experience in CEECs.
Second-order repercussions, as the direct investment activity matures, depend on the export creation, import substitution, and profit repatriation associated with the initial investment.
See the linkages between long-run and short-run determination of the equilibrium exchange rate in MacDonald (1997).
For an attempt at identifying the reasons and forms of contagion effects, see Kaminsky and Reinhart (1998).
Even under relatively stable conditions, price- and cost-based indicators of competitiveness are subject to a number of limiting assumptions (unchanged technology, demand structure, output mix) that are not likely to hold beyond the short run; see Lipschitz and MacDonald (1992). The assumption underlying the ULC-based index, namely that other factor costs move in tandem with labor costs, is not overly restrictive; see Kopits (1982) for a comprehensive measure of unit factor costs. Other shortcomings include underlying statistical sampling problems and breaks in the series.
In all the charts, an upward (downward) movement of the exchange rate indicates appreciation (depreciation).
Vulnerability was also apparent in the high and rising ratio of the stock of broad money (M2) to official foreign exchange reserves in 1996 (Table 3). The rationale for using this ratio as an indicator of vulnerability to financial crises is developed in Calvo (1998).
The large stock of nonperforming loans, including those inherited from the previous socialist regime, also reflect legal impediments to writing off such loans.
By comparison, it is interesting to observe that in Argentina, as expected under a currency board arrangement, inflation has remained equivalent to the rate (less than 2 percent yearly) in the anchor currency area.
No reliable ULC-based measure of the real effective exchange rate is available for Estonia.
The impact of both crises was much stronger in Slovakia. Short-term interest rates jumped above 45 percent and the exchange rate fell below the 7.5 percent margin; the peg was abandoned by end-October 1998.
See the discussion of the experience of Argentina, Chile and Uruguay with the preannounced crawling peg in McKinnon (1981).
For the most part, high inflation and marked exchange rate depreciation in these economies has been induced by monetized fiscal expansion; see Fischer, Sahay and Vegh (1996).
See Kopits (forthcoming).
Estonia is due to shift automatically to the euro as the anchor currency. Hungary and Poland have announced substituting the euro for European currencies in the basket, effective January 1999, but retaining the U.S. dollar with its present weight
On the compatibility of inflation targets with exchange rate bands in shock-prone developing countries, see Leiderman and Bufman (1996). For a theoretical analysis of inflation targeting in an open economy, see Svensson (1997).
See discussion of exit strategies for countries seeking greater exchange rate flexibility in Eichengreen and Masson (1998).
Central banks of ERM2 participating countries are not required to engage in automatic and unlimited intervention to defend the declared parity with the euro if this conflicts with the price stability objective.
Introduction of this rule—implicit under the gold standard and more recently followed by France during the convergence to EMU—along with capital controls temporarily, during such an episode, has been advocated for accession countries by McKinnon (1997).
The opposite approach—apparently followed to a large extent in Czech Republic, prior to the 1997 crisis—that is, of slowing down the restructuring process for the sake of exchange rate and price stability, is highly counterproductive in that it simply delays the necessary relative price adjustments and fuels demand pressures, which eventually lead to an unsustainable external imbalance.
According to Article 109j of the Treaty, as part of the obligation to qualify for Stage 3 of EMU, EU members are required to observe “the nominal fluctuation margins provided for by the exchange rate mechanism of the EMS, for at least two years, without devaluing against the currency of any other Member State.”
As indicated above, all the lead accession countries, with the exception of Slovenia, have reached this stage of external liberalization.
However, after having liberalized these flows, it is very difficult to retreat by reimposing restrictions on them.
The schedule for capital liberalization, under the Act, was postponed (with the possibility of further extensions) for Greece, Ireland, Portugal, and Spain, from July 1990 until January 1993. Moreover, a safeguard clause permitted a member country that suffered monetary and exchange rate disturbances stemming from short-term capital movements to reimpose controls for a six-month period.