1/2002 Andreas Freytag. Accession to EMU and exchange rate policies in Central Europe: Decision under institutional constraints

Working Papers of Eesti Pank. No 1, 2002

Currently, five Central and Eastern European (CEE) countries are negotiating about the membership in the European Union: Czech Republic, Estonia, Hungary, Poland and Slovak Republic. There is a broad consensus that they will eventually become members of the European Monetary Union. This requires careful analysis of the appropriate exchange rate regime prior to the accession. The exchange rate arrangement of the EU applicants plays an important - but not exclusive - role in their policy-mix. The history of transition economies as well as of other emerging markets illustrates that exchange rate policies as such are not a distinctive factor for the success and failure of monetary policy with respect to price stability. In this paper it is argued that this outcome has not emerged by chance. There is no naturally superior exchange rate regime that can be applied to all advanced countries in transition aiming at stability. By way of contrast, an exchange rate arrangement is part of the monetary regime, which itself is a component of the economic order. The latter consists of both politically chosen and spontaneously evolved institutions. This leads to the hypothesis that the choice of an exchange rate arrangement in CEE is constrained by this institutional setting. The theoretical considerations as well as empirical evidence indeed suggest that for guaranteeing stability, beside the legal monetary commitment (part of which being the exchange rate regime) the institutional framework in the country is decisive. If the latter matches the commitment, the credibility of a monetary regime is relatively high, obviously encouraging monetary stability. Therefore, the institutional setting in each country should be analysed extensively before an exchange rate arrangement is chosen.

Author's e-mail address: andreas.freytag [at] uni-koeln.de

The views expressed are those of the authors and do not necessarily represent the official view of Eesti Pank.

Contribution to the research project "Alternatives for Exchange Rate Regimes in Advanced Transition Economies" of the ICEG, supported by ACE. It very much benefited from the discussions at project workshops in Budapest, Portoroz and Vienna. I gratefully acknowledge research assistance by Jörg Wiegratz.
PD Dr Andreas Freytag, Institute for Economic Policy, University of Cologne, Pohligstr. 1, 50969 Cologne, Germany, Phone: ++49 221 470-5348/47, Fax: ++49 221 470-5350.

CONTENTS

Introduction
I Potential Exchange Rate Regimes prior to EMU Membership
II Exchange Rate Regime, Monetary Commitment and Institutions:
Theoretical Considerations
III Exchange Rate Policies in Central Europe: The Appropriate Choice?
IV Conclusions: Lessons for CEE Countries
References

Accession to EMU and Exchange Rate Policies in Central Europe - Decision under Institutional Constraints, Working Papers of Eesti Pank, No 1, 2002 (PDF*)

* To read PDF file, you need Adobe® Acrobat® Reader™ freeware, it may be downloaded from Adobe homepage.