Zdeněk Tůma, Governor, CNB
Speech for The International Atlantic Economic Society, Vienna conference
Vienna, 14th March 2003
Ladies and gentlemen, dear colleagues,
I am honoured by the privilege to be here today and to have the opportunity to exchange opinions with you on what is a challenging and exciting topic -monetary policy during EU and EMU accession. We meet just a few weeks before the accession treaties will be signed to confirm what will become the largest-ever one-off enlargement of the European Union. As a result, the earlier theoretical debates on what challenges might be associated with accession to the EU - and later on also to the EMU - have now shifted towards the practical level of finding how best to cope with these challenges. In many respects, the academic - and usually open-ended - discussions of the pros and cons of the integration process now need to be replaced by action to design the actual steps to be taken.
These steps must necessarily take into account the particular circumstances of each accession country, such as its current economic situation, monetary policy regime and fiscal stance. For example, the roadmap towards the EMU in a country with a currency board will be completely different from that of an inflation-targeting country with a floating exchange rate. This makes my task today quite difficult, as I am expected to give remarks that are sufficiently general for the accession countries as a group, but at the same time specific and focused enough to reflect the current stage of development.
Let me point out the most important issues in the debate on the challenges of EU/EMU accession. The potential trade-off between the real and nominal convergence processes has received particular attention in these discussions. It has been questioned whether the accession countries can simultaneously achieve low inflation, nominal exchange rate stability, consolidated public budgets and sufficiently fast economic growth. It has often been 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.
In my opinion this potential conflict 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 GDP growth is likely to lead to a real exchange rate appreciation, making it impossible to have both very low inflation and a completely stable nominal exchange rate. Nevertheless, my position is that the two processes are not incompatible, and that they have different time horizons. Nominal convergence is achievable in the medium run, whilst real convergence remains a long-term matter.
Most of the accession countries have achieved impressive results in the nominal convergence process. They are now among the countries with 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 achieving 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 imbalances in the economy rather than consequences of ambitious anti-inflationary policies.
As far as real appreciation is concerned, at the current stage we need to shift from purely qualitative judgements to a more practical level. 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 than can be readily explained by economic theory. We thus need quantitative analyses of its causes before we can make any policy judgements for the future. For example, the majority of 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 deregulations, 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, the real appreciation does not necessarily have to be a significant problem either in the ERM2 - as its wide fluctuation band gives room for a modest strengthening - 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.
This is not to say, of course, that fast-track adoption of the euro is a universal best option for all accession countries. As I said at the beginning, there is no single prescription for all the accession countries. In many cases, the practical constraint seems to be the public budgets. Notable exceptions are the Baltic States and some other economies for which there seem to be few obstacles to early eurozone entry. But many other countries run large public deficits, even after subtracting one-off transition costs. The necessary reforms would have to include changing the public finance structure to address the ageing problem, overly generous social security systems, etc. These are problems shared by all European countries, and are politically quite hard to resolve. The consolidation of public budgets to a sustainable position is thus one of the key immediate challenges, both for some accession countries and for the 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 been fully realised and appreciated yet. There are two possible reasons for this. First, it may be due to the fact that the application of sanctions will be postponed until a country becomes a member of the eurozone. But even if a country is not subject to sanctions, as a member of the EU club it should have in place at least a credible programme towards achieving its objectives. Second, there is uncertainty on how the S_G Pact will look in the future. Concerning this point, I believe that some rules of this kind will always have to be in place in the eurozone. They are justified both as part of the trend towards rules and greater transparency in economic policies, and - in the EMU context - also by the need to deal with the free-rider problem in the absence of fiscal federalism. Certainly, it is possible - and probably also reasonable - to think about modifying the existing rules to make them less rigid, for example by defining them in terms of the structural budget balance and by taking sustainability issues (such as lower debt) more directly into account. Nonetheless, it is clear that the current levels of public deficits in some of the accession countries will not be tolerable under any thinkable rules, as the deficits are largely structural in their nature and related to the long-run unsustainability of some public spending programmes.
Finally, I would like to mention an issue that has to be decided by the accession countries' central banks rather quickly - their strategy as regards ERM2 membership. The proponents of the ERM2 regime argue that it 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, but at the same time provides enough flexibility. Even though there is no doubt a valid point in all these arguments, some of the accession countries' central banks - including the CNB - have expressed much less enthusiasm about the ERM2. It may be argued that the disciplining impact is already embodied in the other Maastricht criteria. Moreover, a managed float combined with inflation targeting may achieve the same goals concerning reduced exchange rate volatility and finding the conversion rate, and at the same time avoid the danger of self-fulfilling speculative attacks on the exchange rate's fluctuation bands. In reality, however, the ERM2 exchange rate criterion is - for political reasons - quite unlikely to be modified or cancelled in the near future. On the practical level, the question is thus not whether or not to enter the ERM2, but rather how to minimise its risks by choosing the appropriate timing, suitable central parity, supportive policy mix, etc.
All these are questions that are occupying our minds at present. I believe we will succeed in finding the correct answers and making the right decisions. On the monetary front, the progress with European enlargement should be smooth.