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On the Way of EMU Enlargement towards CEECs: What is the Appropriate Exchange Rate Regime?

  • Maurel, Mathilde

Focusing on a very rich panel of exchange rate regimes in transition countries, this Paper asks the question of the appropriate exchange rate regime for countries aiming at joining the EU, that is, subsequently, the EMU. Four arguments plead in favour of the adoption of a fixed exchange rate regime: (i) countries sharing the same currency inside a Currency Union (CU hereafter) trade well above the average, because of lower transaction costs; (ii) emerging countries are not able to manage counter-cyclical policies; (iii) in a world of increasing financial instability, only corner solutions are feasible; (iv) last, but not least, fixing CEECs currencies could be a necessary step in a global strategy of entering the EU, that is, subsequently, the EMU. This Paper examines the first of these four arguments, that is, the fostering of trade, and provides evidence that the extra trade implied by fixing the currency is in fact close to nil, as in Padko and Wall [2000]. One corollary is that the benefit from membership into the EMU, if any, cannot be explained by the transaction cost argument only. Besides fixed effects, the explanation of the level of trade integration is to be found in the external constraint. The latter is affected by trade (positively if intra-industry trade dominates), and by monetary and fiscal policy. Increasing government spending and manipulating the exchange rate or moving towards more floating regimes might make business cycles more symmetric, relax the external constraint, and finally favour further trade integration. Given that the co-variation of East-West business cycles is already dominated by intra- industry trade, one can conclude that joining the EU, that is, two years later, the EMU, is realistic and compatible with any exchange rate regime. Empirical evidence from Transition Countries shows that the exchange rate regime is not correlated with any fundamentals – better macro-economic performance, higher growth, or deeper trade integration – and should not allow to discriminate between candidate countries for entering the EU (as for other nominal criteria).

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 3409.

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Date of creation: Jun 2002
Date of revision:
Handle: RePEc:cpr:ceprdp:3409
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  1. Flandreau, Marc & Maurel, Mathilde, 2001. "Monetary Union, Trade Integration, and Business Cycles in 19th Century Europe: Just Do It," CEPR Discussion Papers 3087, C.E.P.R. Discussion Papers.
  2. de Melo, Martha & Denizer, Cevdet & Gelb, Alan, 1996. "From plan to market : patterns of transition," Policy Research Working Paper Series 1564, The World Bank.
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  11. Cheikbossian, Guillaume & Maurel, Mathilde, 1997. "The New Geography of Eastern European Trade," CEPR Discussion Papers 1580, C.E.P.R. Discussion Papers.
  12. Michael R. Pakko & Howard J. Wall, 2001. "Reconsidering the trade-creating effects of a currency union," Review, Federal Reserve Bank of St. Louis, issue May, pages 37-46.
  13. Anne Marie Gulde & Juha Kähkönen & Peter Keller, 2000. "Pros and Cons of Currency Board Arrangements in the Lead-Up to EU Accession and Participation in the Euro Zone," IMF Policy Discussion Papers 00/1, International Monetary Fund.
  14. Kutan, Ali M. & Pautola-Mol, Niina, 2002. "Integration of the Baltic States into the EU and Institutions of Fiscal Convergence," BOFIT Discussion Papers 1/2002, Bank of Finland, Institute for Economies in Transition.
  15. Lionel Fontagné & Michael Freudenberg, 1999. "Endogenous Symmetry of Shocks in a Monetary Union," Open Economies Review, Springer, vol. 10(3), pages 263-287, July.
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  17. Hamilton, C.B. & Winters, L.A., 1992. "Opening Up International Trade in Eastern Europe," Papers 511, Stockholm - International Economic Studies.
  18. Brada, Josef C & Mendez, Jose, 1988. "Exchange Rate Risk, Exchange Rate Regime and the Volume of International Trade," Kyklos, Wiley Blackwell, vol. 41(2), pages 263-80.
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  20. Kutan, Ali M. & Pautola-Mol, Niina, 2001. "Integration of the Baltic states into the EU and institutions of fiscal convergence: A critical evaluation of key issues and empirical evidence," ZEI Working Papers B 10-2001, ZEI - Center for European Integration Studies, University of Bonn.
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