Adopting the Euro in Central Europe:

Upon entry into the European Union (EU), countries become members of the Economic and Monetary Union (EMU), with a derogation from adopting the euro as their currency. This paper examines likely economic developments and policy challenges for the five former transition countries in central Europe (the Czech Republic, Hungary, Poland, the Slovak Republic and Slovenia) which joined the EU in May 2004. These economies operate independent monetary policies but have not yet achieved policy convergence with the rest of the euro area.

Preface

ix

Abbreviations

xi

Overview and Policy Conclusions

1

(11)

Scope of the Study

1

(1)

A Framework for Decisions on the Timing of Euro Adoption

2

(1)

Long-Term Benefits and Costs

2

(2)

What Do the CECs Bring to Euro Adoption?

4

(1)

Requirements for Successful Participation in EMU

5

(1)

The Maastricht Criteria and ERM2

6

(2)

Strategies for Meeting the Maastricht Criteria

8

(4)

Assessing the Long-Run Benefits of Euro Adoption

12

(6)

Gains from Trade

12

(4)

Beyond Trade: Benefits on Income and Investment

16

(2)

Long-Term Costs of Losing Monetary Policy

18

(22)

How Do the CECs Stack Up on the OCA Criteria?

19

(9)

How Useful Is the Exchange Rate as a Shock Absorber?

28

(5)

What Do General Equilibrium Models Say?

33

(3)

Appendix 3.1. Cluster Analysis

36

(1)

Appendix 3.2. Output Response to Shocks Under Different Exchange Rate Regimes---Graphical Analysis

37

(3)

What Do the CECs Bring to Euro Adoption?

40

(7)

Income Gap

40

(1)

Economic Size

40

(1)

Capital-Labor Ratios

40

(1)

Capital Inflows

40

(1)

Investment

41

(1)

Real Appreciations

41

(1)

Inflation

41

(1)

Financial Sectors

41

(1)

Fiscal Deficits

42

(1)

Unemployment

42

(1)

Appendix 4.1. Measuring Balassa-Samuelson Effects

42

(5)

Vulnerabilities During Euro Adoption

47

(36)

Getting the Parities Right

47

(1)

Capital Account Volatility

48

(8)

Credit Booms: Risks and Responses

56

(14)

Macroeconomic Booms

70

(3)

Appendix 5.1. Methods of Exchange Rate Assessment

73

(6)

Appendix 5.2. Estimating Credit Behavior in the Euro Area

79

(4)

Institutional Arrangements for Entering ERM2 and Adopting the Euro

83

(3)

The Path Toward Euro Adoption

83

(1)

ERM2: Rules and Questions

84

(2)

Strategies for Euro Adoption

86

(37)

Taming Fiscal Deficits

86

(14)

Controlling Inflation While Stabilizing the Exchange Rate: Will It Be Possible?

100

(4)

Choosing Parities

104

(4)

Monetary Policy Frameworks

108

(8)

Appendix 7.1. Estimation of the Impact on Growth of Fiscal and Monetary Policy

116

(7)

Acting Chair's Concluding Remarks, Executive Board Seminar, February 18, 2004

123

(3)

Bibliography

126

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Adopting the Euro in Central Europe: Challenges Ofthe Next Step in European Integration

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