Sunday, May 28, 2006

Real GDP growth in CEECs

Again, just some data and graphs - comments and a discussion should follow at some point.


Figure 1. Developments in yearly real GDP, (1989=100), 1989-2005.
Source: Groningen Growth and Development Centre . Note: colors represent from top to bottom(according to 2005 value): Green - old EU (Spain, UK, France, Germany, Italy), yellow - CEEC-5 (Poland, Slovakia, Slovenia, Hungary, Czech R.), red - Baltics (Estonia, Latvia, Lithuania), blue - candidates (Romania, Croatia, Bulgaria).



Generally, the CEEC experienced a major slump in GDP at the beginning of the transition in the early 1990s, which was subsequently followed by a rebound, but for some of the countries returning to official pre-1990 levels of real GDP took more than a decade.
Noticeably, the Baltics experienced the largest declines. Real GDP fell by a third to almost a half - starting in 1991, before the countries proclaimed their independence - and continuing to fall till 1994 (Latvia and Lithuania) and 1993 (Estonia) - which roughly coincides with the times of fixing the currencies in these countries. Ever since the recovery in the Baltics is on track, although in the former two, the pre-1990 levels were reached just recently.
On the other hand, in Poland, where the fall was relatively small, and short-lasting, and the recovery could be felt already in 1992, while 1989 levels where exceeded in 1995. This is the reason why the Polish economy, despite a slowdown in the early 2000s and recently slower (relative to other CEEC NMS) growth, still remains the one with the largest cumulative growth since pre-transition times.
The Czech and Slovak Republics recovered relatively quickly, already in 1993 - the year of the "divorce" - both countries started growing. The Hungarian experience was similar, however out of these three countries, the return to pre-1990 levels occurred in the late 1990s in Slovakia, while the Czech Republic, where the initial slump was relatively modest, underwent a crisis in 1997 and retained its pre-1990 real GDP levels a couple years later.
Slovenia, underwent a short slump in 1991-1992 but recovered subsequently, superseding pre-transition levels in late 1990s.
For a comparison, the graph includes EU 4 biggest members, who grew by 20% (Italy) to 60%(Spain) during the examined period, the current candidate countries, Romania and Bulgaria, the slump was longer lasting, and growth picked-up later. Both are now near to official 1989 levels.

Now, for the growth of per capita GDP in the last decade, we refer to Figure 2.


Figure 2. Real GDP (PPS) per capita relative to EU-25 (1995 and 2006, forecast).
From left to right: Germany, France, Italy, UK, Greece, Spain, Portugal, Czech R., Estonia, Latvia, Lithuania, Hungary, Poland, Slovakia, Slovenia, Bulgaria, Croatia, Turkey.
Source: Eurostat

Slovenia and the Czech Republic have levels of GDP per capita similar to the ‘Cohesion States’, actually slightly higher than those of Portugal. Poland despite its early transition recovery remains among the poorest EU states, together with the Baltics, which however, have saw the biggest rises during the past decade. Hungary and Slovakia have also grown relative to the EU average, and are currently at close to 60% of the EU average GDP per capita.

Sunday, May 07, 2006

Re: Re: Exchange rate regimes in selected Transition Economies

And so, a comment sparked by your comment:

Yes, inflation targeting has proven relatively successful in the CEECs, but the success has been more in bringing down inflation, than in allowing the countries to adopt the euro.
So, in my opinion the fixed exchange rate arrangements of the Baltics need not be condemned. Sure, if we take as the main criteria the goal to enter the EMU asap after entering the EU – the fixed exchange rate, as it seems, failed to guarantee them entry in 2007. But entering the EMU is not just about fulfilling or not the inflation criteria by a few decimal points. It is not obvious that the Baltics would have made it, had they let their exchange rate float and adopted an inflation targeting regime. First of all, Slovenia, probably the only CEEC that will adopt the euro next year is not, and in fact never was an explicit inflation targeter. Moreover none of the inflation targeters (and especially Poland and Hungary) are close to fulfilling the Maastricht criteria. Of course, one could say that does not, at the moment, seem a priority to policymakers in those countries. This is communicated through distant or even undeclared (Poland) target EMU-entry dates, but this may be a sheer result of pragmatism i.e. learning not to (officially) desire what one can not achieve, or perhaps the fear of committing and not being able to live up to it.

So perhaps Slovenia was actually the only one that was bound to enter the Eurozone – this is sheer speculation, but I am in favor of saying that at least part of the good shape of the Baltic States according to the Maastricht Criteria (at least the four non-inflation ones) is owed to… their fixed exchange rates.

Currency boards or fixed exchange rate pegs are in fact a tool to combat inflation, as it is attempt to ‘borrow’ credibility by giving up the control of monetary policy. As the credibility should be proportional to the commitment to the regime, a currency board is as highly credible as it is hard to unwind (as for instance ‘unfixing’ a peg is relatively easier). Though this argument is often disputed (a currency board is not perfectly credible) it may be useful to note that perhaps the credibility of monetary policy in the Baltics, at the dawn of transition, was especially low even in comparison to the other now-NMS – mainly for historical and developmental reasons. Thus in the specific circumstances the currency board may have been a better way of achieving stability, low inflation and high growth than the routes chosen by other NMS.
As we are back to our speculations – with the lack of credibility, bringing down inflation may require (at least until the credibility is acquired) quite high interest rate – which, if in place, may have been an impediment to growth in the Baltics, or finally, may have caused trouble in fulfilling the interest rate criterion.

Not to forget, a fixed exchange rate requires a “money-dominant” regime – the maintenance requires a sound fiscal policy and local shocks can be taken care of only through fiscal policy. This requires a prudent stance during upturns in order to be able to accommodate the shocks when things get worse. While the Baltics maintained sound fiscal policy, avoiding a similar crisis to Argentina, even during the Russian Crisis, all the floating regime countries had relatively profligate fiscal stances – as the consequences of such could not be as dangerous to stability as in a fixed exchange regime. And as it turns out it is the persisting fiscal deficits that are the main impediment to Euro adoption in the ‘floating’ NMS.

Dejan, you mention (rightly) that inflation targeting regime enables the country to focus on domestic shocks and therefore it enables the central bank to focus on domestic supply and demand disequilibrium, which could be harmful to the economy. However true this may be, the argument has another side to it – exchange rates can be a source of shocks themselves ( Artis and Ehrmann show that this is possible even in very well established market economies, which suggest it can be of even higher importance in volatile transition countries).
As for your argument that inflation targeting is easily understood by the public and thus highly transparent – I tend to disagree. Why should the setting of the inflation target (which in the history of CEECs was quite often missed – for instance in Poland), the issue of monetary transmission and the setting of the interest rate be more transparent than tying your currency fixed to the euro? I do not think the transparency of the fixed regimes is substantially lower. Finally, Slovenia, had arguably one of the less transparent regimes of a managed float - and yet is about to join the EMU.

Thus the issue, in my opinion, is rather the insistence to execute a criteria that is flawed by construction (in this I agree with Buiters and Siberts comment in the FT 04/05/06). As the ability to develop and reform while maintaining the fixed exchange rate has proven the Baltics suitable for the EMU, this is a much more sensible benchmark than for instance a 0.07% points excess (of the MT criterion benchmark, see FT 01/05/06 ) inflation in Lithuania.

Just to sum up, by no means am I trying to argue that inflation targeting is ‘wrong’, or inferior to a currency board, as I agree with you on most of its virtues - I just claim, that perhaps it would not have helped the Baltics on their way to the euro.

Tuesday, May 02, 2006

Re: Exchange rate regimes in selected Transition Economies

I will reflect on the posting of different exchange rate regimes in the CEECs. In the literature, the exchange rate regime is a mirror image of the monetary regime since central banks can either try to control the exchange rate or inflation, but not both at the same time.
In the late nineties inflation targeting monetary regime was adopted explicitly in three new European Union countries: the Czech Republic in 1997, Poland in 1998 and Hungary in 1998, while Slovakia was also implicitly an inflation targeter from 1999.
Since inflation in these countries in the first years of the regime was higher than the Maastricht inflation criterion, some questioned its suitability and favoured fixing the exchange rate instead and preferred the currency board arrangements.
Inflation targeting regime indeed has some negative features: the targets are difficult to specify and actual inflation in the new entrants to the EU was comparatively unstable relative to the long-term inflation trend. On the other hand, the inflation targeting regime enables the country to focus on domestic shocks, while the fixed exchange rate can not. Therefore it enables the central bank to focus on domestic supply and demand disequilibrium, which could be harmful to the economy. In addition, inflation targeting is easily understood by the public and thus highly transparent.
The inflation targeting regime could be seen as an option for countries with recent high inflation like Bulgaria and Romania or as a viable alternative to currency board (Lithuania and Estonia) or hard peg (Latvia) monetary strategies for EMU accession. Although these monetary regimes were also successful in keeping inflation low, the recent bad performance of two currency bouard countries (Estonia and Lithuania) on their way to the EMU is rising doubt whether to target inflation is a better strategy to pursue.