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

Reflections on the Czech debate about pros and cons of single currency € Ministry of finance of the Czech Republic May 2006

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

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?)

Inflation differentials in Eurozone Source: Eurostat. Monthly values of yearly averages of harmonised index of consumer prices.

Adjustment without exchange rates Source:Ahearne, A., Pisani-Ferry, J.: The euro: only for the agile. Bruegel policy brief, February 2006.

Growth deceleration as symmetric shock ?

Euro – potential source of inflation ? Price level (EU-25 = 100) GDP per capita (EU-25 = 100) Source: Centrum of economic studies VŠEM, Bulletin 07/2006

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)

Critique of Maastricht criteria • Some technical parameters are outdated or questionable • Inflation - who are the outliers?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 appreciationtolerated • One-sided stress on nominal convergence and neglect of the OCA arguments • Missing prioritisation • Lack of credible reference values • Inconclusiveness of the OCA tests

Trade openness of the Czech economy

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

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

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