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Prepared by Craig Beaumont.
The participating central bank has primary responsibility for the stability of their exchange rate within ERM II, as interventions by the European Central Bank (ECB) to support the currency of an ERM II member must not impinge on the ECB’s primary objective of price stability. Timely realignments of central parities will be encouraged.
The Balassa-Samuelson effect on inflation equals the share of nontraded goods multiplied by the difference between labor productivity growth in the traded and nontraded goods sectors. See Masson (1998) for a derivation.
Ball (1994) finds that sacrifice ratios for faster disinflations are lower while controlling for the output-inflation trade-off for each country in non-disinflation periods, suggesting that the result does not just reflect the ability of countries with a low sacrifice ratio to disinflate faster. Interestingly, a study of European transition economies by Christoffersen and Doyle (1998) found no evidence of significant costs for disinflation, except, however, when substantially reducing a moderate inflation rate while maintaining a pegged exchange rate.
This perspective is supported by the initiation of aggregate employment growth in 1998, at 1.2 percent in the first half compared to the first half of 1997. Strong labor productivity growth, at 3.2 percent economy-wide in 1997, and 9.3 percent in manufacturing, suggests room for continued moderate real wage increases.
Finland may provide an example of interest, as during the approach to EMU Finland included “catch-up” clauses in its incomes policies. These clauses never came into effect, but were designed to give confidence to employees that they would not take a risk of real wage losses by accepting wage rises based on the inflation targets.
Sobczak (1998) finds that in Spain, the commitment to participate in EMU, and the implementation of fiscal policy consistent with this goal, generated credibility improvements that were that main element underlying the disinflation in 1996–97.
Countries with a sufficient degree of convergence may seek narrower fluctuation bands against the euro, but this must be approved by the European Commission, the Economic and Financial Committee, the ECB, and the finance ministers of the euro-area countries.
Poland has widened its crawling band in steps to ±12.5 percent by October 1998, and it intends to float the zloty by gradually widening the band and reducing the rate of crawl, National Bank of Poland (1998), whereas the Czech Republic and Slovakia have moved to managed floats.
Sterilization liabilities include short-term (one-day, one-week, and one-month) deposits (formerly reverse repos) of banks with the NBH, and one-year NBH bills.
The key one-month reverse repo rate was cut from 19.75 percent to 19.5 percent on February 6, 1998 and to 19.25 percent on March 2, in comparison to a cut in the annualized rate of crawl of 1.2 percent.
The differential is calculated against German and U.S. interest rates weighted as in the basket, using the actual rate of crawl in place over the next three months.
The reserve requirement on domestic liabilities—denominated in either forint or foreign exchange—is 12 percent, with remuneration of 10 percent in December 1998, relative to Treasury bill yields of 16.4 percent.
Masson notes that a currency board may minimize the risk of speculative attacks, potentially making a fixed peg feasible. Dornbusch and Giavazzi (1998) recommend that CEE countries adopt currency board arrangements to attain a robust fixed exchange rate. Vujec instead proposes that the ECB form an exchange rate arrangement with the CEE countries negotiating to enter the EU as a means to make a peg feasible prior to their entry. Temprano-Arroyo and Feldman (1998) note that while no such pre-EU accession arrangement is officially envisaged, it is likely to be high on the EU political agenda.
Of Hungarian goods exports, 71 percent were to the EU in 1997, of which 87 percent were manufactures.
Widening the band will not itself lead to an appreciation, as the higher exchange rate risk will increase the risk premium on forint denominated assets.
This strategy was used by Portugal in the face of large capital inflows prior to its ERM entry in April 1992, by expanding the fluctuation margins to a few percentage points around the central parity in October 1990. Renewed inflows in mid-1991 were met by a tightening of capital controls, rather than a further widening of the band, perhaps partly reflecting the relatively narrow ERM bands at the time.
A new Act on the National Bank of Poland (NBP) came into effect on January 1, 1998, making price stability the primary objective of monetary policy, while also requiring the NBP to support the government’s economic policy so long as this did not conflict with the primary objective. The NBP elaborated a policy framework centered on inflation targets in October 1998, National Bank of Poland (1998). There are no intermediate targets for money, interest rates, or the exchange rate, these being policy instruments or indicators for achieving the inflation targets. The medium-term objective is to lower inflation below 4 percent by 2003.
An operation to securitize the foreign exchange revaluation losses of the NBH effective on January 1, 1997 strengthened the financial independence of the NBH, though it retains claims on the government with below market interest rates.
Interest rates are the most frequently excluded CPI item in Table 5, but interest rates are not included in the Hungarian CPI.
The Czech National Bank has chosen to focus monetary policy on “net inflation,” which excludes changes in administered prices. The National Bank of Poland has announced that inflation performance relative to the targets will be verified using underlying inflation indicators as well as the official CPI.
Examples of models that attempt to achieve this goal are Poloz et al (1994), and Black et al (1997). Both models used calibration techniques as well as traditional estimation, due to problems experienced with estimating models with plausible economic properties. This would suggest that the structural change that Hungary has experienced need not be an insurmountable barrier to the eventual development of a model.