The Euro and the New Member States

Transcription

1 The Euro and the New Member States Natalia Tamirisa International Monetary Fund Warsaw, October 29, 2007

2 Focus Macroeconomic challenges NMS face as they prepare to join EMU Policies that can help overcome these challenges For details, see Euro Area Policies: Selected Issues, Country Report No. 07/259, July 31,

3 Maastricht Treaty Requires NMS to adopt the euro But only after they satisfy entry conditions Timing is left open EC and ECB review progress annually (Convergence Reports) Unilateral euroisation is inconsistent with the Treaty

4 Entry Conditions Inflation should not exceed, on a sustainable basis, by more than 1.5% that of the three best performing EU countries in terms of price stability Exchange rates should be within the normal fluctuation margins provided for by ERM-II; no devaluations Long-term interest rates should not exceed by more than 2% that of at most the three best performing EU countries in terms of price stability The fiscal deficit should not exceed 3% of GDP Gross government debt should not exceed 60% of GDP

5 NMS plan to adopt the euro, but for now have different exchange rate regimes Exchange Rate Regimes in the NMS and Euro Adoption Plans Progress in Euro Adoption IMF Classification 1/ ERM II EMU Czech Republic Float Has not joined yet No official target date has been set. On current budget plans, 2012 would be the earliest feasible date. Hungary Intermediate Has not joined yet No official target date has been set. The Convergence Program of December 1, 2006 aims at meeting the Maastricht criteria in Poland Float Has not joined yet No official target date Slovak Republic Fixed Joined on November 28, 2005 Target date is set for January 1, 2009 Estonia Fixed Joined on June 28, 2004 The government is committed to adopting the euro at the earliest possible date, which it now estimates to be 2011, based on current inflation forecasts. Latvia Fixed Joined on May 2, 2005 According to the information released by the Ministry of Finance, in 2007 the Government would discuss a new target for the changeover to the euro, tentatively in Lithuania Fixed Joined on June 28, 2004 No official target date has been set. According to the government, Lithuania will aim to join the euro area as soon as possible and the more favorable period for the country to join the euro area starts in Bulgaria Fixed Has not joined yet Target date is set for January 1, 2010 Romania Float Has not joined yet Target date is set for January 1, 2014 Sources: IMF Annual Report on Exchange Arrangements and Exchange Restrictions and International Financial Statistics ; European Commission; European Central Bank; National central banks. 1/ "Fixed" includes currency boards, conventional pegs, and narrow bands. "Intermediate" includes tightly managed floats and broad bands. "Float" includes managed and independent floats. 2/ Information available from European Commission and national authorities, as of end-july, 2007.

6 Questions relevant for euro adoption What are benefits and costs of euro adoption for NMS and the euro area? Is fulfilling the entry criteria feasible for NMS? Will NMS economies perform well in the monetary union? How much policy adjustment would NMS need to undertake to fulfill the entry condition?

7 What are benefits and costs of NMS euro adoption for NMS and the euro area?

8 Benefits and Costs of Euro Adoption Elimination of exchange rate risk More trade and investment Faster convergence (1% per year) But loss of a shock absorber Efficiency gains for the euro area through outsourcing and competition

9 Is fulfilling the entry criteria feasible for NMS?

10 Relative price level NMS are converging to the euro area in real and nominal terms NMS: GDP per Capita and Prices, (In percent of EU-25 levels) BG CZ EE HU LV LT PL SK SI CR RO Relative per capita GDP at PPPs Source: World Economic Outlook, IMF staff estimates. Note: Countries shown on the chart include Bulgaria (BG), the Czech Republic (CZ), Estonia (EE), Hungary (HU), Latvia (LV), Lithuania (LT), Slovenia (SI), Poland (PL), Slovak Republic (SK), Romania (RO). Price convergence results in real appreciation

11 One of the factors driving real appreciation is the Balassa-Samuelson effect

12 Other factors Persistent equilibrium effects Quality upgrading of tradables and nontradables Shifts in domestic preferences toward services EU transfers Transient equilibrium effects (level adjustment) Shifts in foreign preferences towards NMS products EU accession and adoption of acquis communitaire Disequilibrium effects Irrational exuberance, speculative flows, overheating

13 Uncertainty about equilibrium appreciation rates contributes to controversy over criteria Can the built-in margins 1.5% under inflation criterion and 15% under exchange rate stability criterion accommodate equilibrium real appreciation in NMS? Yes Real appreciation is largely transient, and Balassa-Samuelson and other equilibrium effects are small No Catching-up euro-area economies posted 3-3.5% inflation in , above the Maastricht reference value The Maastricht reference value may be driven down by idiosyncratic factors (administrative and tax changes) (Choueiri, Ohnsorge, and van Elkan, forthcoming)

14 Real appreciation is taking place in the context of convergence-driven booms...

15 ...supported by capital inflows

16 Rising concerns about overheating and balance sheet mismatches Foreign Currency-Denominated Loans, 2005 (in percent of total outstanding loans) East Asia Czech Republic Slovak Republic Western Europe Poland Hungary Latin America Bulgaria NMS Romania Lithuania Estonia Latvia Source: National authorities, Fund staff estimates. Note: Regional averages for East Asia and Latin America cover emerging market countries.

17 Cooling off convergence-driven booms is Fiscal tightening difficult Significant? Medium-term considerations? Monetary tightening Further capital inflows? Sterilization costs? Capital controls Prohibited under EU rules? Effective? Prudential regulation As a macro instrument?

18 Will NMS economies perform well in the monetary union?

19 Strong productivity growth, may not be sustainable...

20 Bulgaria Romania Poland Latvia Lithuania Slovak Estonia Hungary Malta Portugal Czech Republic Slovenia Greece Spain Cyprus France Italy Germany Belgium Finland Netherlands Austria Ireland Luxembourg Malta Portugal Italy Spain Cyprus France Belgium Germany Austria Netherlands Luxembourg Ireland Greece Finland Slovenia Hungary Poland Lithuania Romania Czech Bulgaria Slovak Estonia Latvia...but significant catch-up potential remains 90,000 80,000 GDP PPP per Capita, 2006 (in U.S. dollars) 90,000 80, GDP PPP per Capita, 2006 (annual percentage change) ,000 70, ,000 60,000 50,000 United States 50, ,000 30,000 Euro area 40,000 30, United States Euro area ,000 20, ,000 10, Source: IMF, World Economic Outlook.

21 Measures of labor market flexibility provide comfort but have not been tested

22 Product market flexibility is lower than in the euro area

23 Significant presence of major foreign banks should facilitate intertemporal risk-sharing...

24 ...but NMS financial systems are still less developed and integrated than its peers

25 Automatic stabilizing properties of NMS budgets are weaker than in the euro area...

26 ...but variation in expenditures is higher, especially in discretionary categories

27 How much policy adjustment would NMS need to undertake to fulfill the entry conditions?

28 Dynamic Stochastic General Equilibrium Model (GIMF by Kumhof and Laxton, 2007) Fiscal and monetary policy reaction functions Overlapping generations, open economy monetary business cycle model Blanchard (1985) and Weil (1989) Non-Ricardian features: finite planning horizons and liquidity constrained consumers Calibration to a representative NMS

29 Fiscal policy cannot permanently reduce inflation in NMS with pegs NMS: Effects of a One-Percent Permanent Decrease in Fiscal Deficit (In percent or percentage point deviation from the baseline) Flexible Exchange Rate Fixed Exchange Rate Real GDP Inflation Nominal exchange rate Real interest rate Real exchange rate Real GDP Inflation Real interest rate Real exchange rate "+" indicates depreciation "+" indicates depreciation -2.0 t t+1 t+2 t+3 t+4 t t t+1 t+2 t+3 t+4 t Source: IMF staff estimates.

30 Greater wage and price flexibility and lower nominal rigidities reduce output costs... NMS with Fixed Exchange Rate Regimes: Effects of a One-Percent Permanent Decrease in Fiscal Deficit (In percent or percentage point deviation from the baseline) Base Case More Flexible Labor and Product Markets Lower Nominal Rigidities Real GDP Inflation Real interest rate Real exchange rate Real GDP Inflation Real interest rate Real exchange rate Real GDP Inflation Real interest rate Real exchange rate "+" indicates depreciation t t+1 t+2 t+3 t+4 t "+" indicates depreciation t t+1 t+2 t+3 t+4 t "+" indicates depreciation t t+1 t+2 t+3 t+4 t Source: IMF staff estimates....but do not make inflation reduction sustainable

31 In NMS with flexible exchange rates, monetary tightening can lower inflation... NMS with Flexible Exchange Rates: Effects of a One Percent Interest Rate Increase (In percent or percentage point deviation from the baseline) Real GDP Inflation Real interest rate Real exchange rate Nominal exchange rate "+" indicates depreciation t t+1 t+2 t+3 t+4 t+5...but cannot resolve the tension between joint price and exchange rate stability objectives

32 What margin to use for unanticipated inflation and fiscal shocks? Prudent fiscal deficits are estimated at 1-2 percent of GDP Schadler et al, 2005

33 What sacrifice ratios to use to quantify output losses from disinflation? Euro area: 1.25% of GDP Coffinet, Matheron, Poilly (2007) EU-15: 0.5% to 3.5% of GDP Bulir and Hurnik (2006) NMS: 1.5% to 4% of GDP Bulir and Hurnik (2006) Pegs: short-run multipliers from GIMF

34 What levels of inflation to use? Upper limit: Contemporaneous inflation But could be influenced by transient factors Lower limit: Long-run equilibrium trend Average euro area inflation (just under 2 percent) Add 1.5% for Balassa-Samuelson effects Compare to 2.5% adjusted reference value

35 Upper limit on output losses associated with disinflation Lower limit is percent of GDP

36 For fiscal tightening, there is a trade-off between short- and long-run effects

37 Conclusion NMS face considerable macroeconomic challenges are they prepare for joining EMU Distinguishing benign appreciation in NMS from overheating is difficult Degree of appropriate macroeconomic adjustment is uncertain, but could be significant In any event, NMS need to be well prepared before joining to perform strongly in EMU Benefits of euro adoption are considerable for both for NMS and the euro area