1. Real Convergence of the Czech Economy Major Issues for Euro Adoption Tomáš Holub Conference „Deset let eura – inspirace pro ČR “ Prague, 25 November 2008

2. Outline How far have we progressed with convergence; Real appreciation trend; Exchange rate or inflation channel; Experience of the eurozone members; Real exchange rate appreciation and euro adoption; Summary and conclusion.

3. Real Convergence Since 1995 Real convergence so far much stronger in terms of the relative price level than the GDP level; Czech Republic gradually losing its outlier status (2008 price level around 70 % of EU-13).

4. Real Convergence – Regional Comparison Real appreciation by far exceeding the GDP growth differential in CZ, HU, SK, and to some extent in PL; Only SI is different.

5. Real Exchange Rate vis-à-vis the Eurozone The CZK‘s real appreciation since 1993 the second strongest in the region, after SKK.

6. Exchange Rate or Inflation Channel? CZ HU PLSK Exchange rate channel starts to dominate with a floating exchange rate once the disinflation is achieved; HU: inflation channel clearly dominant. Source: Komárek, Koprnická, 2008

7. Exchange Rate or Inflation Channel? EE LT LVSI Inflation channel dominant under fixed exchange rate regime (if fixed against EUR – see LT a LV). Source: Komárek, Koprnická, 2008

8. Experience of Current Eurozone Members (1980-2007) Some convergence in 6 countries out of EU-12.

9. Experience of Current Eurozone Members (1980-2007) Before euro adoption, price convergence went more than fully through the inflation channel with depreciating ERs; Except of AT, euro adoption thus improved price stability.

10. Experience of Eurozone (1999-2007) Inflation differentials after the euro adoption: 55-60 % of these can be explained by price convergence.

11. Real Appreciation and Inflation Differential After Euro Adoption The room for price level convergence is still significant; Estimates around 1.5 – 3.0 a year for most countries. (PC t = 31.95 + 0.71 GDP PPP,t + 0.92 AR(1) t )

12. Summary and Conclusions Most countries in the region have experienced faster catch-up in terms of the price level than the GDP; The Czech Republic is unique in having exploited the ER channel more than the inflation differential; None of the current eurozone members followed this route; But this does not mean they escaped from the price- convergence logic after the euro adoption; The estimated future real equilibrium appreciation for the countries in our region ≈ 1.5 – 3.0 a year; How serious is this problem (inflation differential, low or even negative real interest rates, etc.)?

13. Thank you for your attention. (Tomas.Holub@cnb.cz)