Exchange Rate Options of Future EU Members in Central and Eastern Europe

The eastward expansion of the EU to a community of at first twenty and later twenty-five countries will have numerous accompanying problems, both for the old and new EU member states. One of these problems is the choice of an exchange rate regime for the accession candidates before they join the EU and ultimately the European Monetary Union, i.e. the transition to fixed exchange rates. For some countries that chose fixed exchange rates at the beginning of transformation (by linking their currency to one or several currencies) but them chose to adopt a more or less flexible regime, the process will have come full circle. In the transitional phase, the growing liberalization of capital flows implies a choice between two poles: fixed exchange rate ties without an independent monetary policy or flexible exchange rates to monetary-policy autonomy. Solutions that lie between these poles, which still exist in several countries, are not viable options, as Poland has recently demonstrated. For the small Baltic countries the advantages of a fixed link to the euro (e.g. by means of currency boards) are obvious. Firstly, the EU is an important or their most important trading partner. Secondly, the financial markets receive an anchor for the long-term expectations. And thirdly, the countries are too small for an effective, independent monetary policy. For the accession candidates that have made the most progress in stabilization and the creation of institutions (Poland, Hungary, Czech Republic, Slovenia), a greater flexibility in exchange rates is still appropriate. For a third group of countries that have not yet fulfilled the requirements for EU membership, the link to the euro would be advantageous because it would allow them to import sound macroeconomic policies, to reduce inflation rapidly, and to acquire the confidence of the financial markets.