Zdeněk Tůma, Governor, CNB
Introductory remarks
Panel Discussion: "Euro Extension"
Frankfurt, 21st November 2003
Ladies and gentlemen,
In May of next year we will experience an enlargement of the European Union, which in many respects will be different from previous ones. First, the number of acceding countries is unprecedented, which requires deeper thought about the decision-making mechanisms at the EU institutions. Second, the economic level of the new EU countries will be much lower on average, even compared with the least developed current members, implying stronger challenges for long-run convergence than ever before. Third, the accession countries are entering the EU after the creation of the monetary union, which means that immediately upon EU accession the policy focus will shift towards future adoption of the euro, which may come quite soon in some cases.
Time has now become very pressing. The earlier theoretical debates on what challenges might be associated with accession to the EU - and later on the EMU - have now shifted towards the practical level how to cope with these challenges. The academic discussions of the pros and cons of the integration process now need to be replaced by action.
One issue that we have had to cope with was the uncertainty surrounding the position of the EU's institutions on the speed of eurozone enlargement and the interpretation of the rules. We have heard many general comments on the benefits of the ERM2 system. It has been argued that this regime is a useful monetary policy framework that can have a disciplining impact on domestic policies, limit exchange rate volatility, and help determine the conversion rate for EMU entry, yet at the same time provides enough flexibility. There is no doubt a valid point in all these arguments. It does not mean that the ERM2 is better than other monetary policy frameworks. It has also its weaknesses. That is why - on the practical level - the question is not whether to enter the ERM2, but rather how to minimise its risks by choosing the appropriate timing, suitable central parity, supportive policy mix, etc. To do this, we need to be given a clear interpretation of how the exchange rate criterion will be assessed.
Similarly, we have heard many general comments on the optimal speed of euro adoption, usually cautioning against a fast-track approach. Such universal statements inevitably ignore many country-specific circumstances, such as the current economic situation, monetary policy regime and fiscal stance. In this respect, the accession countries can be divided in two broad groups. First, there are the countries with pegged exchange rates, for example currency boards with the euro as the anchor currency. I do not see any reason why countries with a hard peg to the euro, which have proven their ability to live without their own monetary policies without severe tensions should be discouraged from fast eurozone entry. In their case, accession is clearly beneficial, as it reduces the residual risks with no apparent costs. On the other hand, the roadmap to the EMU might be completely different for the countries with floating exchange rates and inflation targeting regimes.
The general nature of the earlier debates is partially understandable. In the previous period, the political and analytical focus was on EU accession in both the EU and the accession countries, while eurozone enlargement seemed to be the distant future and thus not an imminent priority. Now, our debates have shifted to a more advanced level. Interpretations have been given by the EU institutions on the convergence criteria and, most importantly, the exchange rate stability criterion. These interpretations will no doubt be the subject of further policy discussions in the near future. At the same time, a broader consensus seems to have emerged that there is no universal prescription for all the accession countries regarding euro adoption.
Other debates have also shifted to a more pragmatic level. For example, the potential trade-off between the real and nominal convergence processes received particular attention in the earlier academic discussions. It was questioned whether the accession countries can simultaneously achieve low inflation, nominal exchange rate stability, consolidated public budgets and sufficiently fast economic growth. It was often argued that economic growth should be given priority at the current stage, and only later on should the nominal convergence goals be pursued more vigorously.
It is true that the current level of GDP in most accession countries is well below the EU average. But we should avoid oversimplified conclusions. First of all, even in this respect one can distinguish between two groups of countries. On the one hand, GDP in PPP in the more advanced accession countries varies between 50% of the EU average to more than 70%. On the other hand, there are countries with GDP at or below 40% of the EU level, including Poland and the Baltic States. If one wanted to tie the accession date strictly to GDP, the recommendation would have to be different for those two groups, ruling in favour of the former. Paradoxically, though, it has mostly been the countries from the latter group, i.e. the Baltic States, which have so far demonstrated their ability to achieve real convergence simultaneously with low inflation and consolidated budgets, without having independent monetary policies. These countries are among the prospective early entrants, regardless of their GDPs.
Second, if we wanted to condition eurozone entry on GDP, it is clear that the enlargement would be postponed for decades rather than years. For me, this would mean a radical change of rules. The focus should be put on cyclical and structural convergence as important OCA criteria, rather than on the absolute GDP level.
Third, at this stage of the debate it is also necessary to be quantitative, rather than qualitative, in discussing the implications of the real convergence process for monetary policies and EMU enlargement. In my opinion, the potential conflict between real and nominal convergence has quite often been exaggerated. There are certainly links between the two convergence processes. For example, fast disinflation through tough monetary policy would be connected with a temporary growth slowdown. It is also true that faster potential GDP growth is likely to lead to real exchange rate appreciation, making it impossible to have both - very low inflation and completely stable nominal exchange rate. Nevertheless, my view is that the two processes are not quantitatively incompatible, and moreover, they have different time horizons. Nominal convergence is achievable in the medium run, while real convergence remains a long-term matter.
Most of the accession countries have achieved impressive results with nominal convergence. They now enjoy moderate, or even very low, inflation rates, and their nominal interest rates have converged to the EU levels. In the majority of cases, no practical problems with meeting the Maastricht criteria on inflation and long-term interest rates are envisaged. Moreover, this progress has often been achieved simultaneously with satisfactory growth performance. Admittedly, some countries have gone through economic recessions that have helped them with disinflation, but these were usually reactions to previous macroeconomic and structural imbalances in their economies rather than consequences of overly ambitious anti-inflationary policies.
As far as real appreciation is concerned, it is true that most of the accession countries have exhibited a clear trend towards real exchange rate strengthening over recent years. Moreover, in many cases - including the Czech Republic - its pace has been fairly high, more so than can be readily explained by economic theory. However, we need quantitative analyses of its causes before we can make any policy judgements for the future. For example, the majority of the empirical studies of the Balassa-Samuelson effect have concluded that this hypothesis explains only 1-2 percentage points (or even less) a year of the real appreciation in the Central European countries. The rest must be explained by other factors, such as price deregulation, quality and terms-of-trade improvements, and structural changes in the economy. It is quite likely that these effects will become less important in the medium term, slowing down the equilibrium real appreciation. Therefore, real appreciation does not necessarily have to be a significant problem either in the ERM2 or in the eurozone. In other words, the real appreciation might be modest enough not to pose a serious conflict with low inflation and satisfactory economic performance.
Another practical issue that we must acknowledge at this stage is that in many countries the practical constraint on the timing of eurozone accession is the public budget. The Baltic States are notable exceptions, but many other countries run large public deficits, even after one-off transition costs are subtracted. The necessary medium-term reforms include changing the public finance structure to address the ageing problem, and overly generous social security systems. These are problems shared by all European countries and are politically quite hard to resolve. It is therefore not surprising that we have so far seen only the first - albeit very important - reform steps in many countries. These will need to be followed by further, more decisive measures, but a potential danger from delay exists. The consolidation of public budgets to a sustainable position is thus one of the crucial challenges for the accession countries (but also for many present EU members). 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. This is something that has not yet been fully realised and appreciated, perhaps partly due to the absence of sanctions for the countries outside the eurozone. But an absence of sanctions should not be viewed as an excuse for not trying to achieve the Pact's objectives in the medium run.
Finally, I would like to stress that there are also practical issues to be addressed on the EU's side, including the future of the Stability and Growth Pact or further clarification of the convergence criteria. The eurozone is still an infant institutional arrangement that needs further evolution. And the enlargement process should be viewed as a stimulus and catalyst for such changes, rather than an obstacle to them.