Download Impact of lower US growth on eastern Europe Willem Buiter

15-012002
Anchor, Float or Abandon Ship:
Exchange Rate Regimes for the Accession Countries
Willem Buiter
&
Clemens Grafe
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.
Capital Account Restrictions
Country
Capital Controls
Romania
controls on capital market securities, money market instruments, derivatives, credit
operations, real estate transactions.
Bulgaria
controls on capital market securities, money market instruments, derivatives, credit
operations, real estate transactions.
Slovak Rep.
controls on capital market securities, money market instruments, derivatives, credit
operations, real estate transactions.
Poland
some controls on short term capital, direct investment and purchase of land by
foreigners
Slovenia
some controls on short term capital, direct investment and purchase of land by
foreigners
Czech Rep.
largely liberalised, but some minor restrictions remain especially on the purchase of land
by foreigners
Hungary
almost fully liberalised except for some restrictions on the purchase of land by
foreigners.
Latvia
almost fully liberalised except for some restrictions on the purchase of land by
foreigners.
Lithuania
almost fully liberalised except for some restrictions on the purchase of land by
foreigners.
Estonia
almost fully liberalised except for some restrictions on the purchase of land by
foreigners.
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
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-cumde facto unilateral euroisation; (2) ‘consensual’ euroisation with
Council-agreed conversion rate).
• Anything else goes, incl. currency board, euro as parallel
currency.
Monetary Regimes: Current Practice
Country
Nominal Target/Exchange Rage Regime
Czech
Republic
Managed float against Euro, headline inflation target; 3-5% band
for 2002
Hungary
Managed Float since 2001, inflation target
Poland
Managed float since April 2000, headline inflation target
Romania
Managed float
Slovak
Republic
Slovenia
Managed float, core inflation target
Latvia
Currency peg (exchange rate fixed at 0.8 Lats per SDR)
Bulgaria
Currency board (fixed at the rate of Lev 1.955.83 per Euro)
Estonia
Currency board (fixed at the rate of EEK 15.69664 per Euro)
Lithuania
Currency board (fixed at 4 LTL per US Dollar, to be switched to
euro on February 2, 2002).
Managed float, annual M3 growth target
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
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.
Openness I
1998
Trade % of GDP Trade % of GDP
(current prices) (PPP)
Group 1
Czech Republic
Estonia
Hungary
Poland
Slovenia
Group 2
Bulgaria
Latvia
Lithuania
Romania
Slovak Republic
121
169
102
56
115
44
58
42
26
67
91
109
106
60
139
23
37
40
15
46
Openness II
Trade (% of GDP)
% of GDP
(current prices)
1986
1998
% of GDP
(PPP)
1998
1986
Group of EU late joiners
Greece
44
40
15
19
Ireland
103
141
88
134
Portugal
63
72
22
44
Spain
38
56
18
37
62
77
36
59
Averages
Average late EU joiner
Average group 1
113
48
Average group 2
101
32
Asymmetric Shocks I
Trade with EU + group Trade with EU Trade with EMU
1 % of total trade
% of total trade % of total trade
Group 1
Czech
Republic
Estonia
Hungary
Poland
Slovenia
Bulgaria
Latvia
Lithuania
Romania
Slovak
Republic
Average
75
62
77
73
76
68
60
73
67
70
58
55
43
72
54
62
59
39
65
60
64
38
30
32
56
49
49
AS shocks II :Sectoral structure
Source: WDI
Manufcturing %
of value added
1986
1995
Agriculture % Agriculture male
of value added employment*
1986 1997
1990
1997
Average EU 85
22
4
2.4**
5.6
4.5
Average EU late
joiner
Greece
Ireland
23
18
9
6.1**
17.4
14
15
10
13
9
11.2**
6.3**
20.5
20.7
18
15
Spain
26
18
7
3.0**
12.6
10
Portugal
29
25
6
4.0**
15.6
12
Average EU 95
19
3.7**
8
Average group 1
23
5
13
Czech Rep.
Estonia
Hungary
7
18
24
4
7
6
Poland
Slovenia
21
29
5
4
21
12
11
GDP comparisons
Trade (% of GDP)
Table 5
Share of relevant EU
av.
(current prices)
1986
1997
Share of relevant EU
av. (PPP)
1986
1997
Accession (% of curr. EU)
Czech Rep.
Estonia
Hungary
Poland
Slovenia
Average
EU late joiners (%of EU85)
Greece
Ireland
Portugal
Spain
Av. EU late join. (%of EU 85)
Av.EU late join.(%of curr. EU)
25
15
21
18
44
25
46
64
31
57
62
49
55
85
49
63
77
63
57
35
46
35
67
48
62
48
49
62
36
69
68
76
62
68
59
77
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
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
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).
Balassa-Samuelson meets the EMU exchange
rate and inflation criteria.


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
 A E   g A g A  g E  g E
T
N

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







T
N




 
BS effect could be large enough to endanger
inflation criterion with a fixed exchange rate
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.
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.
