György Szapáry Central European University

1. Monetary Policy during Transition: Issues and Challenges in the New EU Members, with Lessons for Latin America and Asia György Szapáry Central European University György Szapáry Central European University

2. Characteristics • The EU’snew member sates (NMS) are characterized by: • Small, fully open economies • Catching-up economies • Integrated to EU economy with euro adoption expectations György Szapáry Central European University

3. GDP per capita at PPS (EA12=100) György Szapáry Central European University

4. Price level (EA12=100) György Szapáry Central European University

5. 3-month interbank interest rate differential György Szapáry Central European University

6. Domestic credit / GDP György Szapáry Central European University

7. GDP per capita, credit growth, inflation György Szapáry Central European University

8. Share of foreign currency loans (in percent of total loans), 2006 György Szapáry Central European University

9. Challenges • Domestic monetary policy can be circumvented by FX loans • Negative or very low real interest rates, coupled with low initial level of credit/GDP, generate rapid credit growth. • Euro adoption expectation attract foreign capital that finances unsustainable fiscal and/or current account deficits György Szapáry Central European University

10. Current account balance / GDP György Szapáry Central European University

11. Performance under Maastricht György Szapáry Central European University

12. Euro Adoption • Cyprus, Malta Slovenia: January 1, 2008 • Slovakia: expected January 1, 2009 • Baltic countries: meet all criteria except inflation criterion. Hoped to adopt early (entered ERM2), but have difficulties to control inflation with fixed exchange rates. • Bulgaria: entered ERM2, keen to adopt, but difficulty controlling inflation under currency board. • Hungary, Poland: „as early as possible” but no dates set. • Czech Republic, Romania: not in a hurry György Szapáry Central European University

13. EU Procedures • For euro zone members: Stability Reports, yearly • For non-euro zone members: Convergence Reports, yearly • Stability and Growth Pact (SGP) • For all EU members: Excessive Deficit Procedure (EDP) as long as fiscal deficit above 3% of GDP, yearly examination, but there is also enhanced procedure with half yearly examination, e.g., Hungary • Steps: EU Commission→Economic and Financial Committee (EFC)→Council of Ministers of Finance (ECOFIN) György Szapáry Central European University

14. Currency Unions in Latin America and Asia? • There is often talk to create a currency union in LA and Asia. • Is it just talk or a realistic option? • Do potential candidate LA and Asian countries meet the necessary requirements for creating a currency union? György Szapáry Central European University

15. Share of Exports to EA12 and EU27 (in percent), average of 2004-2006 György Szapáry Central European University

16. Share of Exports to MERCOSUR-4, Associate members-6, and US (in percent), 2006 György Szapáry Central European University

17. Trade Intensity in Asia(in percent of total trade) György Szapáry Central European University

18. Business Cycle Synchronisation with the EA12, 1995-2007 Using the Hodrick-Prescott filter György Szapáry Central European University

19. BCS in the EMU György Szapáry Central European University

20. BSC in the EU • BCS has increased due to trade integration, endogeneity, Maastricht (less home made idiosyncratic shocks, like fiscal shocks) • See Darvas-Szapáry (2008a) and (2008b) for BCS in enlarged EU, and Darvas-Rose-Szapáry (2007) for BCS and fiscal shocks. György Szapáry Central European University

21. GDP per Capita (1) György Szapáry Central European University

22. GDP per Capita (2) György Szapáry Central European University

23. Infaltion (1)(in percent) György Szapáry Central European University

24. Iflation (2)(in percent) György Szapáry Central European University

25. Iflation (2)(in percent) György Szapáry Central European University

26. Exchange Rate Developments in Latin America (1) György Szapáry Central European University

27. Exchange Rate Developments in Latin America (2) György Szapáry Central European University

28. US Dollar-Asian Exchange Rates György Szapáry Central European University

29. Yen-Asian Exchange Rates György Szapáry Central European University

30. Current Account (1)(in percent of GDP) György Szapáry Central European University

31. Current Account (2)(in percent of GDP) György Szapáry Central European University

32. Budget Balance (1)(in percent of GDP) György Szapáry Central European University

33. Budget Balance (in percent of GDP) György Szapáry Central European University

34. LA and Asia: conclusions (1) • Conditions for countries contemplating to enter into a monetary union: • Free movement of goods and capital: restricted in LA and Asia • A fair degree of trade integration and BSC, but there is also endogeneity: weak in LA and Asia • Convergence of monetary and fiscal policies that leads to convergence of inflation, interest rates and fiscal deficits (as a ratio of GDP): significant progress made in LA and Asia György Szapáry Central European University

35. LA and Asia: conclusions (2) • A period of free capital mobility preceding entry is essential to avoid entering with the wrong exchange rate (raison d’etre of ERM2) • Main risks: within a currency union, the main channel of adjustment is the competitiveness channel through wages and prices, a tough act for regaining lost competitiveness György Szapáry Central European University

36. LA and Asia: conclusions (3) • Need coordination of policies. In the EU this is done by: • Rules: Maastricht criteria, Stability and Growth Pact. • Surveillance frameworks: Excessive Deficit Procedures, Convergence Reports, Stability Reports. Lisbon Agenda. • Frequent meetings at different levels: eg, Finance Ministers (ECOFIN), Deputies (EFC). • Political coordination at broader level. • Coordination took several decades in EU and still needs much strengthening. György Szapáry Central European University

37. LA and Asia: conclusions (4) • Trade integration growing but still weak • Other than trade, little progress in economic integration of services and factor markets • Large differences across countries in per capita GDP and economic structures (commodities), but progress in convergence of inflation and fiscal deficits. • Large country heterogeneity in legal and regulatory standards • Many meetings but little progress in macroeconomic policy coordination • Large political heterogeneity • Thus: still a long way to go for LA and Asia for creating the conditions necessary to form a currency union that would function efficiently for the benefits of all its members. György Szapáry Central European University

38. References • Darvas, Zs. and Gy. Szapáry (2008a), “Euro Area Enlargement and Euro Adoption Strategies”, European Economy, Economic Papers, Number 304, EU Commission. • Darvas, Zs. and Gy. Szapáry (2008b),“Business Cycle Synchronization in the Enlarged EU”, Open Economies Review, Vol. 19(1), pp. 1-19 • Darvas, Zs., A. Rose and Gy. Szapáry (2007): “Fiscal Divergence and Business Cycle Synchronization: Irresponsibility is Idiosyncratic”, in Frankel, J. and C. Pissarides(eds.), NBER International Seminar on Macroeconomics 2005, MIT Press György Szapáry Central European University