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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. A E g A g A g E g E T N 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.