Wednesday, March 08, 2006

Re: Re: Entering the EMU - not such an easy task? - promised article comment

Well, I finally found the mentioned article (FT 30/01/06 p.15 “Monetary union is not for the poor”). The author, W. Munchau, contributes to the discussion on whether Estonia and Lithuania should join the euro, raising the point that the inflation criteria, which the two countries recently do not fulfill, may be used as a neat tool to prohibit (or actually post-pone, though indefinitely) their entry. Further, the author claims that there is not much reasons, on economic and technical grounds, to keep the two Baltic States outside the EMU. However, also ads, that entry may be very harmful for them – because they are “still too poor”.
As with the first case I tend to be in line, with the second, I must disagree. The main argument, repeated after a Bundesbank report, that “the biggest risk lies in the choice of a potentially wrong conversion rate when entering the euro. As we have seen in the case of Germany, which entered the euro with only a moderately overvalued exchange rate, it can take many years to correct such a mistake” , is in my opinion the least important one:
1. The two Baltics have relatively long experience with currency boards (Estonia since 1992, first to DEM then EUR; Lithuania since 1994, first to USD then EUR) and have actually gained quite substantial experience in managing a fixed exchange rate. Having fixed exchange rates for the past years, despite rapid growth, the countries did not see much of the problem of misaligned currencies and this was not even undermined by the Russian crisis. Up till now ‘overvaluation’ has not been a problem.
2. A comparison with Germany and Italy is problematic on the grounds that the Baltic economies appear relatively flexible, and hence I would suppose the adjustment of a potentially overvalued rate would be much quicker.
3. Fiscal policy, which in the (practical) absence of maneuver monetary policy would serve to adjust to shocks, is also relatively sound compared to the “old” members – it has actually served for this purpose during the c.b. and should be well prepared to continue. Estonia has actually maintained a surplus or balance since 1997 (when Eurostat data starts) excluding the 1999 when it responded to the Russian crisis, while Lithuania’s deficit is within reasonable bounds (below 2% 2001-2004), though perhaps should be curbed slightly.
4. Rapid growth is not impossible within the emu ( look at Ireland ;) ) - also, the BS effect can take place, without causing any harm to the economies.
5. current account imbalances, if dangerous at all, seem much more dangerous if the countries stay out maintaining a c.b. than if they adopt the euro.
6. And related to the previous, what that the author omits is the issue of credibility that these countries derive from fixing there currency – which can only be full when they actually adopt it. If they are not allowed to join, then this credibility may be undermined, actually triggering a crisis, even if there is a lack of other fundamental reasons. And if diverse imbalances were to put pressure on the exchange rate, a nominal adjustment within the euro would quite probably be less painful than scrapping the c.b.

What does make me wonder (though on a purely hypothetical basis ;), is the idea raised by J.Rostowski. If these countries are so determined to adopt the common currency, perhaps they could consider doing it unilaterally? And could they actually be stopped from doing so, or would the new status quo have to be eventually acknowledged….


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