Reflections on the Czech debate about pros and cons of single currency

1
Reflections on the Czech debate about pros and
cons of single currency

• Ministry of finance of the Czech Republic May
  2006

2
Euro - culprit of poor growth performance in
Eurozone ?
Source EU Growth Trends at the Economy-Wide and
Industry Levels, European Commission, April 2006
3
Euro - culprit of poor growth performance in
Eurozone ?

• Heard-of arguments
• Unfulfilled promises of pro-federalist
  politicians
• Another rigidity to already rigid Union
• Source of diverging economies
• Counter-arguments
• Productivity deceleration is a longer-term
  phenomenon
• The issue already addressed in 2000 Lisbon Agenda
• What alternative exchange rate arrangement for
  internal market? (wild fluctuations of floating
  rates?, managed realignments in EMS?)

4
Inflation differentials in Eurozone
Source Eurostat. Monthly values of yearly
averages of harmonised index of consumer prices.
5
Adjustment without exchange rates
Source Ahearne, A., Pisani-Ferry, J. The euro
only for the agile. Bruegel policy brief,
February 2006.
6
Growth deceleration as symmetric shock ?
7
Euro potential source of inflation ?
Price level (EU-25 100)
GDP per capita (EU-25 100)
Source Centrum of economic studies VEM,
Bulletin 07/2006
8
Euro potential source of inflation ?

• Supporting arguments
• Loss of the exchange rate channel during the
  catching up process with the EU price level
• Empirical evidence from some Baltic countries
  (Latvia approx. 7 , Estonia 5 inflation, but
  robust growth as well)
• Caveats
• Empirical evidence from Eurozone countries
  (Portugal, Greece, Ireland 2 3 )
• Price differentials mainly observed in
  non-tradable sector while tradable sector is
  exposed to sharp competitive pressures
• Shrinking non-tradable sector and extending
  tradable sector
• The closing of price gap through the exchange
  rate channel can continue until Eurozone
  accession (depends on the ERM-II)
• More thorough analytical work still needed
  (extent of Balassa-Samuelson effect)

9
Critique of Maastricht criteria

• Some technical parameters are outdated or
  questionable
• Inflation - who are the outliers?
• ERM-II narrow fluctuation band 2¼ - potential
  for speculative attacks?
• Will be the trend exchange rate appreciation
  tolerated
• One-sided stress on nominal convergence and
  neglect of the OCA arguments
• Missing prioritisation
• Lack of credible reference values
• Inconclusiveness of the OCA tests

10
Trade openness of the Czech economy
11
Financial openness of the Czech economy

• Absence of any capital controls (CR is integral
  part of the internal EU market)
• EU is the major source of foreign direct
  investment
• Dominant foreign ownership in the Czech banking
  sector (CSOB, CS, KB)
• High trade and financial openness ? growing
  weight of the endogenousness OCA argument

12
Other OCA arguments

• Low synchronisation of business cycles
• Factors spoiling good correlation
• Fast actual economic growth (5 - 6 )
• Monetary shake-up in 1997 and resulting recession
  
• Higher frequency of asymmetric shocks
• Very abstract econometric exercise
• How many of them should by properly addressed by
  the exchange rate policy? Over-representation of
  car-producing industry?
• Insufficient flexibility of labour market
• The OCA is concerned with insufficient
  cross-border mobility (no major problem on the
  Czech side)
• Flexibility of the Czech labour market is not
  worse than that of the EU