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Helpful comments and suggestions from Julian Berengaut, Odd Per Brekk, Paul A. Cashin, Mark Horton, Adalbert Knobl, Stasys Kropas, Raimondas Kuodis, Anne McGuirk, John Odling-Smee, Ratna Sabay, Alfred Schipke, and Mohammad Shadman-Valavi are gratefully acknowledged. Alessandra Merlino contributed to the data-gathering effort.
The Litas Stability Law provided the institutional basis for the CBA (Box 1).
In order to preserve the viability of CBAs, countries need to maintain the required strict policy discipline including a conservative fiscal stance, healthy financial system, cautious external debt management, and flexible labor markets (see Camard (1996), Mihalke (1997), Santiprabhob (1997)).
During 1994–95, under political pressure, the BoL authorized a bank to withdraw required reserves to allow it to lend to a utility company a large amount in foreign exchange, and the government undertook foreign borrowing by pledging official reserves.
Thanks to the CBA, the government was able to resist pressures for monetizing the deposits of failed banks. The total recapitalization cost was about 3 percent of GDP. See Enoch and others (2002), Garcia-Herrero (1997).
The authorities planned to amend the Litas Stability Law in 1999 to formalize the exit from the CBA.
Net foreign assets (NFA) of the BoL, excluding government deposits, declined substantially from end-December 1998 to end-September 1999, as the NFA of commercial banks did.
EU membership also requires compliance with some parts of the Stability and Growth Pact.
The Nice European Council endorsed the compatibility of a CBA with the ERM2.
Accession countries are not bound by the Maastricht criteria before joining the EMU.
The permanent component of the REER was estimated by applying the Hodrick-Prescott (HP) filter to monthly REER series for the period January I995-February 2002 and projections for the period March 2002-December 2002, using an ARIMA (1,1,0) model. Projections are used to avoid end-period distortions induced by the HP filter when only historical data are considered (Kaiser and Maravall (1999)).
Given the short series of terms of trade, it is impossible to determine whether terms of trade shocks were permanent or transient in nature, thus their medium-term impact on REER and competitiveness could not be definitely determined (Cashin and McDermott (2002)).
In the context of modeling the real exchange rate of countries with a currency board, real interest rate differentials (a standard determinant of the equilibrium exchange rate) are likely to be of little relevance, because it is expected that domestic interest rates converge to world interest rates at least in the medium term. However, interest rate spreads are systematically monitored to assess the financial situation and credit standing of the country.
The evolution of the net foreign assets position was obtained by adding up the current account balances. The initial stock of net foreign assets was provided by EDSS.
It is not possible to use data from the early 1990s based on the model. First, before 1994 the data availability for Lithuania and some of its trading partner countries is very limited. Second, the methodology is based on the assumption of functioning markets, which did not hold in the early 1990s due to insufficient progress in transition.
Before proceeding with the multivariate analysis (Table 4), the stationarity characteristics of the series have been tested performing augmented Dickey-Fuller and Phillips and Perron tests. The results indicate that the hypothesis that the variables are integrated of order one cannot be rejected.
An impressive reform agenda is planned in connection with EU accession.
The share of structural unemployment is likely to remain high in the medium-term and exchange rate fluctuations would have a marginal impact on the size of structural unemployment.
An appreciation of the external exchange rate (qx>0)will worsens the competitiveness of the domestic products and consequently the trade balance, when the Marshall-Lerner condition holds.