Zdeněk Tůma, Governor, CNB
Introductory statement
Panel Discussion "Central Bankers' Point of View"
European Banking and Financial Forum 2004
Comenius, Pan-European Society for Culture, Education and Scientific and Technical Cooperation
Prague, 23th March 2004
Ladies and gentlemen,
From the central banks' point of view, the biggest challenge associated with the upcoming EU enlargement is certainly future euro adoption. This fact distinguishes the current EU enlargement from all the previous ones, which took place before the single currency was introduced. As a result, recent years have been marked in all the acceding countries and in the EU institutions by discussions on the optimal euro adoption strategies.
During the debates a clear consensus has emerged that there is no universal path that would suit all acceding countries. The strategies announced by the individual countries thus naturally differ one from another. Two key factors determine the desired strategy: economic readiness for euro area accession and the current monetary policy regimes of each country. All the acceding countries have made substantial progress with nominal convergence under their present regimes. Inflation rates have converged to the EU levels, and long-term interest rates are also in most cases below or close to the Maastricht convergence criterion. A substantial amount of credibility has thus been invested in the existing monetary arrangements, which naturally implies that the acceding countries would like to avoid double regime switches, preferring a smooth and fast transition from the current regime to adoption of the euro.
From this point of view, the acceding countries can be divided into two broad groups. First, there are the countries with currency boards or other pegged exchange rate regimes. Second, there are the economies with floating exchange rates, usually combined with an inflation targeting regime. My distinguished colleague from Estonia, Mr Vahur Kraft, has spoken on the former case. Let me therefore just briefly mention the proven ability of the currency board countries to live without their own monetary policies without severe tensions. This provides a strong incentive for fast-track euro adoption in these countries. The nature of currency boards also argues against a softening of the rules during ERM2 participation.
I will focus on the latter group of countries in my short introductory remarks, i.e. on the inflation targeting countries with floating exchange rates. In general, I believe that adopting the euro will be advantageous to these economies. The benefits relate primarily to the reduction in foreign exchange risk, which should facilitate both trade and financial flows with the eurozone, and to the elimination of the danger of exchange rate turbulence and crises. These expected benefits should in the long run outweigh the challenges associated with giving up national monetary policies and exchange rates as adjustment tools. Consistently with this point of view, most acceding countries have expressed their desire to create conditions for entry within a relatively short period of time.
The actual entry strategies, though, can differ significantly. At this stage, we must acknowledge that in most Central European countries the major practical constraint on the timing of eurozone accession is their sizeable public budget deficits. As the roots are largely structural, the solution needs to include sensitive reforms on both the expenditure and revenue side, which are hard to push through politically and may thus lag behind the original schedule. The case for fiscal consolidation is further strengthened by the fact that upon EU accession the Stability and Growth Pact will become relevant to the new member states. I believe that the recent failure to enforce its rules in the existing euro area member states should not be taken as an excuse for not fulfilling the Pact's obligations. Instead, this should be interpreted as a warning that its targets should be met well in advance and enforced even during good times to create a sufficient buffer for difficult periods.
As a result, the Czech euro adoption strategy announced jointly by the Czech government and the CNB has pointed to the years 2009-2010 as a realistic entry date. Other countries in the region were initially more optimistic about their accession prospects, but recently they have converged closer to our view, forced primarily by fiscal developments.
In this situation, the acceding countries have to address the question of what monetary policy regime to use in the interim period after EU accession but before euro adoption. This is related to the issue of the optimal timing of ERM2 entry, which is a prerequisite for adopting the euro. It also includes the question of whether ERM2 participation is consistent with the inflation targeting regime, or whether it implies a complete change in monetary policy.
In my opinion, it is reasonable to continue with the inflation targeting strategy before euro adoption, even though this conclusion is partly conditional on the way in which the exchange rate stability Maastricht criterion will be assessed. There are at least three arguments in support!of this approach. First, the inflation targeting regime has - after its initial challenging years - achieved a substantial degree of credibility. It would be confusing for the public to go through another regime in the short period of time left before euro adoption. Second, the Maastricht criteria include the inflation criterion and the long-term interest rate criterion, which means that the central bank cannot disregard price developments anyway. The task is to achieve price and exchange rate stability simultaneously, not one at the cost of the other. Third, I do not consider the ERM2 to be a policy regime superior to inflation targeting and a sufficient, self-standing nominal anchor for the economy.
In line with this stance, we have agreed with the government to stay out of the ERM2 mechanism for the time being. We will enter it when conditions for euro adoption and smooth ERM2 participation have been established. Until then, inflation targeting will remain the platform for our monetary policy.
By coincidence, this month we announced our inflation target for the period beyond January 2006. This target is set at 3%, which should allow us to fulfil the monetary side of the Maastricht convergence criteria and at the same time reflects the long-term real convergence needs of the Czech economy.
In any case, the central banks of the acceding countries will have to take into account the constraints imposed by ERM2 participation and by eurozone entry itself. The tightness of these constraints is greatly influenced by the interpretation of the exchange rate stability criterion. A narrow, rigid fluctuation band would aggravate the potential short-term conflicts between achieving all the Maastricht criteria simultaneously and would force the central banks to give priority to short-term exchange rate stability over long-run domestic monetary stability. It is thus very important that the ECB's position published late last year did not insist on the narrow fluctuation band and has highlighted the importance of assessing the economic fundamentals behind the exchange rate movements.
Emphasising the fundamentals is also an important element of the central banks' communication with market participants. The central banks have a crucial role in setting - in agreement with the EU authorities - the ERM2 entry parity and the ultimate conversion rate. Ideally, the eventual central parity should not be far from the market exchange rate or from the central banks' assessment based on the development of fundamentals.
To conclude, let me stress that monetary policy alone cannot guarantee a smooth euro adoption process. It is very important that the whole policy mix supports this goal and contributes to its general credibility. To achieve this, we must continue with the structural reform process, not only to address the aforementioned fiscal problems, but also to increase the flexibility and long-run competitiveness of our economies.
Thank you for your attention.