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1.  15-01-2002 Anchor, Float or Abandon Ship:Exchange Rate Regimes for the Accession CountriesWillem Buiter&Clemens Grafe

2. Strong bi-polar view of feasible exchange rate regimes under conditions of unrestricted financial capital mobility: Free float (only consider free float-cum-inflation targeting). Credible fixed exchange rate (are there credible fixed exchange rate regimes?). Note: Unrestricted financial capital mobility (among members and between a member and non-members) is a precondition for EU membership.

3. Capital Account Restrictions

4. Maastricht conditions for EMU membership: • Inflation (no more than 1.5% above average of 3 lowest inflation countries) • Nominal interest rate (10 year rate no more than 2.0% above average of 3 lowest inflation countries) • Nominal exchange rate • Respect normal fluctuation margins for ERM without severe tensions for at least 2 years before the examination. No devaluation ‘on own initiative’. [Question: can one ‘respect normal fluctuation margins for ERM’ without being an ERM and therefore an EMU member? If not, at least 2 years of ERMII plus unrestricted financial capital mobility: risk of speculative attacks and crises]. Italy and Finland precedents 1998/9; Greece precedent 2000/1. • Council of Ministers decides conversion rate • Financial • Deficit • debt • Central Bank independence

5. Acceptable exchange rate regimes under Maastricht Criteria for EMU membership: • Anything with a central parity in terms of the euro and fluctuation margins < 15%. • Ruled out: • target zone with margins >±15% • free float • unilateral euroisation (but note: (1) euro as parallel currency-cum-de facto unilateral euroisation; (2) ‘consensual’ euroisation with Council-agreed conversion rate). • Anything else goes, incl. currency board, euro as parallel currency.

6. Monetary Regimes: Current Practice

7. Conventional OCA Theory • Go with the flex if: • Nominal rigidities • large and relatively closed in trade • asymmetric shocks (Mundell mark I) • less diversified structure of production & demand • low degree of real factor mobility • no significant supra-national fiscal redistribution

8. Much OCA analysis confuses nominal rigidities and real rigidities. • Much OCA analysis ignores financial capital mobility • N(ew)OCA view: • exchange rate not just a shock absorber, or part of the transmission mechanism for fundamental shocks originating outside the foreign exchange markets, but a source of excess volatility, unnecessary shocks, instability and misalignment. • Mundell mark II: asymmetric shocks an argument for a fixed exchange rate.

9. Openness I

10. Openness II

11. Asymmetric Shocks I

12. AS shocks II :Sectoral structure

13. GDP comparisons Table 5

14. Question: • Is there a perfectly credible fixed exchange rate regime? • Answer: No. But, in order to decreasing credibility: • Formally symmetric, bilateral or multilateral monetary union • Monetary authority • (1) has mandate that spans entire union • (2) acts as lolr on the same terms throughout union • (3) shares seigniorage fairly among all union members • (4) is accountable to citizenry of entire union through legitimate political mechanism • Asymmetric or unilateral monetary union (dollarisation, euroisation) • Currency board (could have euro as joint legal tender - parallel currency) • fixed exchange rate • no dce

15. Currency board only stability enhancing if 4 conditions are satisfied. • Planned (time- or state-contingent) strong exit. • (successor regime must be either free float with inflation targeting or monetary union- unilateral or multilateral in the short run, multilateral in the long run). • No need for lender of last resort, i.e. no wonky banks • No need for dce, i.e. strong fiscal policy & institutions. • Sensible peg (basket possible). • Therefore a sensible currency board should be temporary • either a hyper-inflation breaker • or a pre-cursor to monetary union

16. Inflation targeting: a thing of beauty. Requires: legitimate target; observable, sensible. institutional arrangement that assigns priority to price stability credible toolbox transparent procedures & practices (communication).

17. Balassa-Samuelson meets the EMU exchange rate and inflation criteria. BS effect could be large enough to endanger inflation criterion with a fixed exchange rate

18. Conclusion • All accession candidates should aim to become full EMU members ASP. • Pre-EU • free float with inflation targeting • most credible fixed exchange rate regime. Unilateral euroisation inconsistent with future EMU membership. ‘Consensual’ euroisation worth pursuing. • Post-EU but pre-EMU. • First-best: achieve inflation convergence and join EMU as soon as possible after joining EMU. Could even be at same time as EU, if ERM membership (for at least 2 years) is not required to satisfy normal ERM fluctuation margins. Precedents: Italy, Finland, Greece.

19. Conclusion continued • Second-best: (unavoidable problem: purgatory of unrestricted capital mobility, risk of speculative attacks, collapsing peg, excess volatility, misalignment). • most credible fixed exchange rate regime. Cannot be unilateral euroisation. Could be currency board. Could be currency board with euro as parallel currency. Might even be ‘consensual’ euroisation. Problem with any pre-EMU fixed exchange rate regime : inflation criterion meets Balassa-Samuelson. Could require unnecessary recession for 1 year. • Target zone with margins < ±15%. Problem: risk of excessive volatility, speculative attacks, collapse of band, misalignment.