1. Eesti Pank Bank of Estonia 15 years of currency board in Estonia Ülo Kaasik

2. CBA in Estonia 2 Eesti Pank Bank of Estonia Outline Currency Board Arrangement in Estonia History Framework and results Recent developments and challenges

3. Ülo KaasikCBA in Estonia 3 Eesti Pank Bank of Estonia Why choosing CBA? Need for stabilising anchor in the beginning of 1990s Creating a simple and reliable monetary system, effective since 1992 Small open economy with free capital mobility

4. Ülo KaasikCBA in Estonia 4 Eesti Pank Bank of Estonia Monetary system Fixed exchange rate against euro (since 1999, formerly since 1992 equivalently against the DEM) Full convertibility of Estonian kroon Base money is fully backed by high quality foreign assets

5. Ülo KaasikCBA in Estonia 5 Eesti Pank Bank of Estonia Operational framework Smooth liquidity management through unlimited EUR-EEK exchange with the central bank (forex window) High liquidity buffers in the form of required reserves (reserve ratio currently 15%) No domestic monetary policy interest rate: monetary stance is determined by European Central Bank monetary policy decisions

6. Ülo KaasikCBA in Estonia 6 Eesti Pank Bank of Estonia Other policies supporting CBA Fiscal policy based on a balanced budget principle Tax system – motivating, transparent, simple Liberal trade and investment regime since 1991 Flexible labour market Strong banking system Preparations for EU membership

7. Ülo KaasikCBA in Estonia 7 Eesti Pank Bank of Estonia What are the results?

8. Ülo KaasikCBA in Estonia 8 Eesti Pank Bank of Estonia Relatively quick stabilisation of the economy The introduction of the currency board was crucial in achieving disinflation During the last 8 years the average CPI has been 3.7 % CPI (1991-2007) 1991 -- 257% 1992 -- 1077%

9. Ülo KaasikCBA in Estonia 9 Eesti Pank Bank of Estonia The interest rates have converged to the interest rate level in euro-area countries

10. Ülo KaasikCBA in Estonia 10 Eesti Pank Bank of Estonia Fast capital inflow, through FDI and banking system

11. Ülo KaasikCBA in Estonia 11 Eesti Pank Bank of Estonia Very rapid income convergence Source: Eurostat

12. Ülo KaasikCBA in Estonia 12 Eesti Pank Bank of Estonia … and current account deficit

13. Ülo KaasikCBA in Estonia 13 Eesti Pank Bank of Estonia Pace have accelerated during last years Double digit GDP growth Rapid credit growth Deepening CAD Inflation well above Maastricht criterion

14. Ülo KaasikCBA in Estonia 14 Eesti Pank Bank of Estonia How to avoid overheating of the economy under CBA? Case of Estonia Flexibility: in economic policies and markets Reducing cost and price pressures of the government Reminding conservative financial decisions More reserves in the financial system Close cooperation with supervisors and central banks of the host countries

15. Ülo KaasikCBA in Estonia 15 Eesti Pank Bank of Estonia CBA ensures high liquidity buffers

16. Ülo KaasikCBA in Estonia 16 Eesti Pank Bank of Estonia Flexible labour markets is crucial for economic adjustment

17. Ülo KaasikCBA in Estonia 17 Eesti Pank Bank of Estonia CBA cannot operate without conservative fiscal policy

18. Ülo KaasikCBA in Estonia 18 Eesti Pank Bank of Estonia Is inflation too high?

19. Ülo KaasikCBA in Estonia 19 Eesti Pank Bank of Estonia Lower level of convergence implies faster growth rate

20. Ülo KaasikCBA in Estonia 20 Eesti Pank Bank of Estonia Income and price levels tend to correlate i.e. converge together Price level and GDP per capita in PPS in European Union (except Luxembourg) Source: Eurostat

21. Ülo KaasikCBA in Estonia 21 Eesti Pank Bank of Estonia Apart from conjunctural price increases current inflation rate also reflects price convergence

22. Ülo KaasikCBA in Estonia 22 Eesti Pank Bank of Estonia Economy has started to cool down, 2007 Q2 growth was 7.6%

23. Ülo KaasikCBA in Estonia 23 Eesti Pank Bank of Estonia Credit cycle has turned Monthly credit growth has not declined to a too low level – it remained around 2% during the whole summer

24. Ülo KaasikCBA in Estonia 24 Eesti Pank Bank of Estonia The external balance has not widened any further -20% -18% -16% -14% -12% -10% -8% -6% -4% -2% 0% IIIIIIIVIIIIIIIVIIIIIIIVIIIIIIIVIIIIIIIVIIIIIIIVIIIIIIIVIII*IIIIVIIIIIIIVIIIIIIIV 2000200120022003200420052006200720082009 Current accountSpring forecast 2007 Current account (% of GDP) * Flash estimate

25. Ülo KaasikCBA in Estonia 25 Eesti Pank Bank of Estonia No big impact of financial turbulences

26. Ülo KaasikCBA in Estonia 26 Eesti Pank Bank of Estonia Euro adoption as the ultimate exit clause Adoption of the euro as soon as possible, targeting 2011 Central role of the government in reducing inflation: –Avoiding additional cost and price pressures –Managing regulated prices No changes expected in the monetary environment due to euro adoption

27. Ülo KaasikCBA in Estonia 27 Eesti Pank Bank of Estonia Conclusions CBA can be an effective corner stone for the economy However, CBA cannot be successful without supportive economic policies CBA offers the closest monetary environment to the euro area, preparing the economy for the euro adoption