Ministry of finance of the Czech Republic May 2006

Euro - culprit of poor growth performance in Eurozone ? Source: EU Growth Trends at the Economy-Wide and Industry Levels, European Commission, April 2006

Euro - culprit of poor growth performance in Eurozone ?  Heard-of arguments  Unfulfilled promises of pro-federalist politicians  Another rigidity to already rigid Union  Source of diverging economies  Counter-arguments  Productivity deceleration is a longer-term phenomenon  The issue already addressed in 2000 Lisbon Agenda  What alternative exchange rate arrangement for internal market? (wild fluctuations of floating rates?, managed realignments in EMS?)

Inflation differentials in Eurozone Source: Eurostat. Monthly values of yearly averages of harmonised index of consumer prices.

Adjustment without exchange rates Source: Ahearne, A., Pisani-Ferry, J.: The euro: only for the agile. Bruegel policy brief, February 2006.

Growth deceleration as symmetric shock ?

Euro – potential source of inflation ? Price level (EU-25 = 100) GDP per capita (EU-25 = 100) Source: Centrum of economic studies VŠEM, Bulletin 07/2006

Euro – potential source of inflation ?  Supporting arguments  Loss of the exchange rate channel during the catching up process with the EU price level  Empirical evidence from some Baltic countries (Latvia approx. 7 %, Estonia 5 % inflation, but robust growth as well)  Caveats  Empirical evidence from Eurozone countries (Portugal, Greece, Ireland 2 – 3 %)  Price differentials mainly observed in non-tradable sector while tradable sector is exposed to sharp competitive pressures  Shrinking non-tradable sector and extending tradable sector  The closing of price gap through the exchange rate channel can continue until Eurozone accession (depends on the ERM-II)  More thorough analytical work still needed (extent of Balassa- Samuelson effect)

Critique of Maastricht criteria  Some technical parameters are outdated or questionable  Inflation - who are the outliers?  ERM-II narrow fluctuation band ± 2¼ % - potential for speculative attacks?  Will be the trend exchange rate appreciation tolerated  One-sided stress on nominal convergence and neglect of the OCA arguments  Missing prioritisation  Lack of credible reference values  Inconclusiveness of the OCA tests

Trade openness of the Czech economy

Financial openness of the Czech economy  Absence of any capital controls (CR is integral part of the internal EU market)  EU is the major source of foreign direct investment  Dominant foreign ownership in the Czech banking sector (CSOB, CS, KB) High trade and financial openness  growing weight of the „endogenousness“ OCA argument

Other OCA arguments  Low synchronisation of business cycles  Factors spoiling good correlation Fast actual economic growth (5 - 6 %) Monetary shake-up in 1997 and resulting recession  Higher frequency of asymmetric shocks  Very abstract econometric exercise  How many of them should by properly addressed by the exchange rate policy? Over-representation of car-producing industry?  Insufficient flexibility of labour market  The OCA is concerned with insufficient cross-border mobility (no major problem on the Czech side)  Flexibility of the Czech labour market is not worse than that of the EU