by Jürgen von Hagen and Iulia Traistaru-Siedschlag, Vienna, 2006
A joint publication with the Central Bank of Malta
Introduction: In the years to come, macro economic policies in the new EU member states will face two principal challenges. The first is to manage the continued and probably rapid process of further real economic convergence, which will come with high real GDP and productivity growth rates and large capital inflows. The second is to achieve the degree of nominal convergence required to enter into (the Third Stage of) European Monetary Union (EMU). These two challenges are not unrelated, as rapid growth and large capital inflows can make it harder to achieve nominal convergence, although, as we argue below, there are good reasons to think that real convergence would be easier to manage for some of the countries at least, if they were allowed to adopt the Euro immediately. Both challenges relate mainly to fiscal policy: managing capital inflows, because fiscal policy can absorb part of their demand effects, nominal convergence, because the sustainability of public finances is part of the requirement for entering EMU. Once in EMU, the new member states will have to cope with asymmetric macro economic developments without recourse to monetary and exchange rate policy. This will pose new demands for fiscal and wage policies in particular.
The new member states have achieved considerable macro economic stabilization over the past decade. The Central and East European (CEE) countries among them went through the transition from central planning to market economies, which began with severe recessions, high inflation, and financial instability. Today, inflation rates are well below 10 percent and nominal interest rates have declined, too. Public debt has been stabilized, though high and persistent deficits and the need for further fiscal adjustments are still critical issues in several cases. The ten new members are members with “derogations” from adopting the Euro. Like Sweden, and unlike Denmark and the United Kingdom, they cannot formally opt out of the Euro indefinitely, i.e., they are expected to become full members of the EMU sooner or later. With the exception of Poland, all of them have already announced target dates for this to happen. It is suggested that there are two groups of countries: fast entrants and slow entrants. Estonia, Lithuania, Slovenia, Cyprus, Latvia,Malta and Slovakia have signalled their intentions of a fast entry into EMU by entering the ERM-2, the exchange rate arrangement succeeding the former ERM. Slovenia and Lithuania have officially requested in March 2006 the start of the formal decision-making process for the adoption of the Euro. Convergence Reports by the European Commission and European Central Bank published on 16 May 2006 have concluded that Slovenia fulfilled the Maastricht criteria. Lithuania fulfilled all but the price stability criterion. Subsequently, the ECOFIN Council of 11 July 2006 has approved the adoption of the Euro in Slovenia on 1 January 2007. Lithuania has initially set 1 January 2007 as the official target date for the adoption of the Euro but this is no longer relevant after the negative assessment of the Convergence Reports. A new date has not been announced yet. Cyprus, Estonia, Malta and Latvia aim to adopt the Euro on 1 January 2008. In most of the cases, the changeover to the Euro is foreseen as a “big bang” scenario with Euro banknotes and coins becoming legal tender upon the adoption of the Euro. The Czech Republic and Hungary aim to adopt the Euro in 2010 while Poland has adopted a “wait-and-see” strategy. The Czech Republic and Poland are probably the only two economies large enough to successfully conduct an autonomous monetary policy aiming at price stability. For the other, much smaller and more open economies, in contrast, the value of an independent monetary policy seems very limited.
In this paper, we discuss the challenges for macro economic adjustment ahead. We begin, in section 2, by taking stock of the degree of nominal and real convergence that has already been achieved. In section 3, we turn to the development of public finance in the new member states. In section 4, we discuss the problems arising from the perspective of continued, large capital inflows. Section 5 considers the role of the ERM-2 and the problems connected with convergence towards the adoption of the Euro. Section 6 looks at the task of macro economic adjustment under EMU. Section 7 concludes.
Where We Stand: Real and Nominal Convergence in the New Member States
Public Finance: Size, Structure and Consolidation
Coping With Large Capital Inflows
Convergence to the Euro and the ERM-2
Macroeconomic Adjustment under EMU
Keywords: Euro area enlargement, nominal and real convergence, public finance, macroeconomic adjustment
JEL Codes: E62, F33, F42
ISBN No.: 978-3-902109-34-7
Authors: Jürgen von Hagen and Iulia Traistaru-Siedschlag