Euro Adoption Benefits and Challenges. Jiri Podpiera, Johannes Wiegand, and Jiae Yoo

Transcription

1 Euro Adoption Benefits and Challenges Jiri Podpiera, Johannes Wiegand, and Jiae Yoo June, 215

2 Outline Motivation Institutional Setting Advantages from Euro Adoption Advantages from Preserving Monetary Autonomy What if NMS-6 Join? Conclusions 1

3 1. Motivation 24: last time IMF staff assessed cost/ benefits from euro adoption (Schadler et al.) Since then, several things have changed: Shifts in membership: Slovenia, Slovak Republic, Baltics have joined (or are about to join) the euro. Romania, Bulgaria, Croatia have joined the EU, but not yet the euro. New evidence on cost/benefits in the past 1 years: trade generation within the euro area has been small, e.g., also little business cycle synchronization Large shocks to demand in both NMS and euro area (EA) far larger and different in nature than what was anticipated in 24. Time to revisit the issue 2

4 1. Motivation (2) Illustrate economic benefits and costs from euro adoption In favor enhanced country perception from deeper institutional and economic integration with the EA. Enhanced financial stability due to the elimination of currency mismatches. Cautioning against premature euro adoption loss of monetary policy autonomy. and consider uncertainty around the evolving EA policy framework. 3

5 2. Institutional Setting Current assessment by the EC: EC Convergence Report Fulfillment of Euro Adoption Criteria Legal Price Exrate Fiscal Interest Other stability (ERM2) (no EDP) rates Bulgaria Macro imb Czech Republic (+) 1/ + Croatia Macro imb Hungary Macro imb Poland Romania Lithuania Sweden Macro imb 1/ The Czech Republic left the Excessive Deficit Procedure in 214 Source: European Commission Different monetary regimes: Bulgaria and Croatia peg to the euro Czech Republic, Hungary, Poland, and Romania target inflation, floating exchange rates 4

6 Advantages from Euro Adoption 5

7 S & P Rating (linearized) 3. Advantages: Euro Premium Extract euro premium from: (i) international investor rating (IIR) direct measure of investor perception (ii) S&P sovereign credit ratings. Strictly speaking, the premium measures the impact of euro membership on the perceived distance to default The S&P and IIR Credit Ratings Evolution of Ratings per Country Group 1 3 y = x R² = Euro area EU, not euro Outside EU IIR Rating

8 3. Advantages: Euro Premium (2) Panel regressions, 34 countries Controls for macro variables, institutional quality, EU membership, country specific effects, time dummies C it = X it β + γ t Euro it + θ t EU it + θ t + δ i + u it, Significant positive euro credibility premium Has since vanished S&P downgraded euro area countries by more than IIR NMS today face a different environment than the early euro adopters 4 Standard and Poors Rating Premium for Euro Membership (in rating notches) 18 International Investor Ratings Premium for Euro Membership (in rating points)

9 FX loans to the private sector as share of total 3. Advantages: Currency Mismatches Besides the general euro premium, there can be specific benefits from eliminating vulnerabilities, s/a FX mismatches Liability euroization tends to be sizeable, except for CZR POL Correlate share of FX loans with country-specific effects Suggests that a credibility malus is associated with high currency mismatches can be eliminated with euro adoption Balance Sheet Euroization (FX Loans to the Private Sector as Share of Total) Country Perception and Balance Sheet Euroization (fixed effects, 26-12) 9 Czech Rep. Poland Hungary Romania Bulgaria (May) Latvia Croatia Lithuania Romania Bulgaria Hungary Croatia 4 Slovenia Slovak Estonia R² =.39 Czech Republic Poland Latvia Lithuania Average premium (in IIR points) 8

10 3. Euro Advantages: Summary Enhanced country perception from deeper integration in EA s institutional framework: euro premium has vanished. Prospect for restoration may depend on both (i) the success of ongoing reforms to the euro area s institutional framework, and (ii) global macro-developments: tighter global liquidity conditions, for example, may well increase the value of access to a global reserve currency) Elimination of currency mismatches between euro and domestic currency: still an important factor, but not equally relevant for all economies 9

11 Advantages from Preserving Monetary Policy Autonomy 1

12 4. Advantages: Monetary Autonomy Capacity to set monetary conditions in line with economy s needs, hereby reduce business cycle fluctuations has this been valuable? Note: this is not about whether floating or pegging is better. Peg may be needed to establish a credible anchor, for example. Focus here is on short- to medium-term cycle management only one aspect for the choice of monetary regime We assess three episodes: economic convergence, 23-7 financial crisis of 28-9 and its aftermath, and recent period of , deflationary pressures from global commodity markets and the EA. Compare outcomes for NMSs with monetary policy autonomy to those that pegged exchange rates or had the euro. Seek broad patterns there is heterogeneity within groups, reflecting country characteristics, non-monetary policies, etc. 11

13 4.1 Monetary Autonomy: Convergence During 23-7, NMS reduced income gap with EU15 by about 2 percent. Low capital/labor ratio implied higher return on capital than in EA capital inflows and if not managed could lead to overshooting/imbalances. Exchange rate is important tool convergence triggers real exrate appreciation (B/S, Podpiera effects): (i) low inflation and nominal appreciation tight monetary conditions, or (ii) higher inflation. 12

14 Poland Czech Rep. Hungary Croatia Slovenia Bulgaria Lithuania Estonia Slovakia Romania Latvia Real credit growth 4.1 Monetary Autonomy: Convergence (2) Monetary conditions (interest & exchange rates) were looser among exrate peggers than in IT regimes often even looser than in the EA Translated into asset and consumer price inflation, credit booms, and built-up of excessive debts. High domestic demand growth for countries with fixed exchange rates, but unsustainable (Bakker and Gulde, 21). 8 Growth and Monetary Conditions (Percent; average 23-7; peggers labeled red) Real Credit Growth and Monetary Conditions (Percent; average 23-7; peggers labeled red) Romania Latvia Estonia Lithuania Slovenia Bulgaria y = x R² = Growth differential w/ Euro Area Monetary Conditions differential w/ Euro Area Slovakia Croatia Hungary Czech Republic Poland Monetary conditions (+tighter)

15 Poland Romania Lithuania Bulgaria Czech Rep. Hungary Croatia Slovakia Slovenia Estonia Latvia Domestic demand growth 4.2 Monetary Autonomy: Demand Shock The global financial crisis triggered large and asymmetric demand shock in 28-9, both for NMS and EA. Monetary autonomy allowed CBs to let exchange rate depreciate and cut policy rates. Mitigated demand contraction. Countries with pegged exchange rate tended to have more restrictive monetary conditions and larger contractions in demand. Contributions to Monetary Conditions (28-14 average; percent; peggers labeled red) Monetary Conditions and Domestic Demand Growth (28-14 average; percent; peggers labeled red) Poland y = x R² = Romania 1 Slovakia Czech Republic -2-4 Real Effective Exchange Rate Real Interest Rate Lithuania Hungary Bulgaria Estonia Croatia Latvia Slovenia Monetary conditions (+tighter) 14

16 4.3 Monetary Autonomy: Disinflation Since 212, EA core inflation has been falling. Spillovers into NMS? Inflation variance decomposition (Iossifov and Podpiera, 214) shows that disinflation spillovers are larger for peggers. By contrast, inflation targeting countries could prevent that deflation would spill into core. 15

17 5.What If NMS-6 Join? Implications for countries IT NMS would need to replace monetary autonomy with other instruments: counter-cyclical fiscal policy, macroprudential (MaP) tools, and internal wage adjustments. NMS that peg to euro change in policy environment less significant. But: can they use MaP policies to the same degree in the EA as outside? (Bulgaria and Croatia have been heavy users). Ongoing EA reforms affect fiscal and financial sector governance (fiscal compact, banking union) and their final shape will affect countries policy space in the EA. Implications for euro area Monetary policy stance. If convergence resumes, inflation in EA could increase for a protracted period tighter stance by ECB needed to defend inflation target. 16

18 6. Conclusions Euro premium has diminished with the EA crisis. When (or whether) it will return will depend inter alia on EA governance reforms & global macro conditions Euro adoption continues to hold advantages for highly euroized economies. Monetary autonomy has been a valuable tool for short and medium term demand management (contain macro-imbalances and combat demand/deflation shocks). Replacing it would not be straightforward. Uncertainty about the EA s evolving institutional framework provides a rationale for a wait and see approach. 17

19 Thank you! 18