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Strategic Exchange-Rate Policy of Accession Countries in ERM II

  • Christian Fahrholz

    ()

    (Jean Monnet Centre of Excellence, Free University Berlin)

Exchange-rate policies of Central Eastern European Countries (CEEC) have often been a subject matter. Yet, some new insights in terms of political economy considerations upon exchange-rate policy are provided. It is pointed out that it is more appropriate to analyse exchange-rate policy in course of Exchange Rate Mechanism II (ERM II) with regard to a changing incentive structure. In doing so, considerable moral hazard problems become apparent. ERM II shall provide for an adequate level of convergence between prospective and current members of European Monetary Union (EMU). However, this institutional arrangement and, particularly, its impact on the incentives for exchange-rate policy making might enable CEEC to load considerable costs of convergence onto current members. Accordingly, the phase of ERM II is considered to be a bargaining on the distribution of costs of convergence between prospective and current members of EMU. In return, accession countries would offer to maintain public support for European integration. The CEEC’ leverage in this bargaining rests on brinkmanship, i.e. putting exchange-rate regimes at risk, thus possibly undermining the according public support. This paper delineates the basic assumptions and conditions for successful brinkmanship, points out the specific transmission mechanisms, and characterises this kind of exchange-rate policy as ‘threaten-thy-neighbour’. Overall analysis results in a cautious outlook on probable effects of such strategic exchange-rate policies on European institutional and economic matters.

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Paper provided by Free University Berlin, Jean Monnet Centre of Excellence in its series Eastward Enlargement of the Euro-zone Working Papers with number wp14.

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Length: 29 pages
Date of creation: 01 Apr 2003
Date of revision: 01 Apr 2003
Handle: RePEc:ezo:ezppap:wp14
Contact details of provider: Postal: Jean Monnet Centre of Excellence, Freie Universität Berlin, Ihnestrasse 22, D-14195 Berlin
Web page: http://www.jmc-berlin.org

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