On the Road: The Path of Bulgaria, Croatia and Romania to the EU and the Euro

Abstract

Click to increase image sizeClick to decrease image size Notes For a literature survey on equilibrium exchange rate estimation with a focus on the new EU member states, see e.g. Égert (2003 Égert, B. 2003. Assessing Equilibrium Exchange Rates in CEE Acceding Countries: Can We Have DEER with BEER without FEER? A Critical Survey of the Literature. Focus on Transition, 2: pp. 38 – 106 [Google Scholar]). Apart from the three countries covered in this article the Former Yugoslav Republic of Macedonia and Turkey have also submitted formal applications for EU membership, with Turkey having official candidate status since December 1999. An exchange rate is regarded as misaligned if its actual values persistently deviate from its equilibrium trend. See Fidrmuc & Korhonen (2003 Fidrmuc, J and Korhonen, I. 2003. Similarity of Supply and Demand Shocks Between the Euro Area and the CEECs. Economic Systems, 27, 3: pp. 313 – 334 [Google Scholar]) for an analysis of the correlation in underlying demand and supply shocks between the euro area and the Central and Eastern European countries. Under a currency board, a fixed conversion rate is set between the local and a foreign currency and the domestic monetary base is fully backed by low-risk assets denominated in the foreign currency. The currency board has no right to issue central bank money against any domestic assets. The full working paper version (see Reinhart & Rogoff, 2002 Reinhart CM Rogoff KS The Modern History of Exchange Rate Arrangements: A Reinterpretation NBER, Cambridge, Working Paper 8963 2002 [Google Scholar]) includes also detailed country-specific information on de facto exchange rate regimes. For a discussion on the pros and cons of euroisation in Europe see for example Begg et al. (2003 Begg D Eichengreen B Halpern L von Hagen J Wyplosz C Sustainable Regimes of Capital Movements in Accession Countries Policy Paper 10, CEPR, London 2003 [Google Scholar]). During the 1990s the European Community and its member states progressively concluded Association Agreements, so-called ‘Europe Agreements’, with ten countries of Central and Eastern Europe. The Europe Agreements provided the legal basis for bilateral relations between these countries and the EU. The Balassa – Samuelson effect is a common explanation for the fact that inflation tends to be higher in countries in an earlier stage of economic development. Assume a country with two sectors, an open sector producing tradable goods and a closed sector producing non-tradable goods. Given that wages are assumed to be linked to labour productivity in the open sector and because wages are expected to equalise across sectors, the price level of the closed sector is determined by the productivity level prevailing in the open sector. See Égert & Lommatzsch (2004 Égert B Lommatzsch K Equilibrium Exchange Rates in the Transition: The Tradable Price-Based Real Appreciation and Estimation Uncertainty William Davidson Institute, Michigan, Working Paper 676 2004 [Google Scholar]) and Crespo-Cuaresma et al. (2005 Crespo-Cuaresma, J, Fidrmuc, J and MacDonald, R. 2005. The Monetary Approach to Exchange Rates in the CEECs. Economics of Transition, 13, 2: pp. 395 – 416 [Google Scholar]) for a discussion on the use of the CPI-to-PPI ratio as a proxy of the Balassa – Samuelson effect in Central and Eastern European economies. In June 2004 Estonia and Lithuania joined ERM II with their existing currency board arrangements based on the euro in place. This move imposes unilateral commitments on these countries, while entailing no obligations for the European Central Bank. When interpreting the results, we should keep in mind that exchange rate misalignments estimated on the basis of panel data tend to show higher volatility than those directly based on the individual time series (see e.g. Égert & Halpern, 2004 Égert B Halpern L Equilibrium Exchange Rates in Central and Eastern Europe on the Eve of the Euro: New Insights from Meta-Analysis paper presented at the tenth Dubrovnik economic conference 2004 [Google Scholar]). This conclusion is, however, sensitive to the specification of the constant term in the simulation, which was discussed above. By contrast, alternative derivations of the constant term would result in inconsistent behaviour of the exchange rate, especially during the currency crisis in 1997. Additional informationNotes on contributorsJesús Crespo-CuaresmaWe would like to thank Stephan Barisitz, Vivek Dehejia, Balázs Égert, Doris Ritzberger-Grünwald and an anonymous referee, as well as the participants of the Hohenheim Sommer University 2004 for helpful comments and discussions. Our special thanks go to Andreas Nader for his assistance in data search and Susanne Steinacher for her linguistic support. The views expressed in this contribution are those of the authors and do not necessarily represent the position of the Oesterreichische Nationalbank.