After the crisis: what new lessons for euro adoption? Zsolt Darvas Croatian Parliament 15 November 2017, Zagreb
Background and questions Among the first 15 EU member states, Mediterranean countries experienced unsustainable developments in 1999- (partly related to their euro membership), and their overall economic record is weak Among the 13 countries that joined the EU in 4-2013, 7 countries have entered the euro area. These newcomers are generally converging economies potentially subject to boom/bust developments. What was the macroeconomic performance of euro ins and outs among the newer member states? Did the lack of a stand-alone exchange rate of euro-ins made adjustment since more painful? What lesson to draw for further euro enlargement? 2
Exchange rate regimes of new EU members Euro members Non-euro members entry date regime before regime Slovenia 7 tightly managed Bulgaria currency board Cyprus tightly managed Croatia tightly managed Malta tightly managed Czech Republic free float Slovakia 9 free float Hungary free float Estonia 2011 currency board Poland free float Latvia 2014 narrow band Romania free float Lithuania 2015 currency board With the exception of Slovakia, all new euro members 3 had rigid exchange rate regimes before joining the
Nominal exchange rate against the euro (1995Q1=100) 150 130 Euro members 150 130 Outs Croatia 110 100 90 70 Cyprus Estonia Latvia Lithuania Slovakia Slovenia Malta 110 100 90 70 40 32 24 20 16 12 8 Bulgaria Croatia Czech Republic Hungary Poland Romania 40 32 24 20 16 12 8 60 1995 0 5 2010 2015 Diverse movements 60 4 1995 0 5 2010 2015 Note: increase indicates exchange rate appreciation against the euro 4 4
Real effective exchange rate, based on consumer prices (1995Q1=100) 220 1 Euro members 220 1 220 1 Outs Bulgaria Croatia Czech Republic Hungary Poland Romania 220 1 100 Cyprus Estonia Latvia Lithuania Slovakia Slovenia Malta 100 100 1995 0 5 2010 2015 1995 0 5 2010 2015 Diverse movements Croatia Note: increase indicates exchange rate appreciation against 138 trading partners 5 100
Convergence between 1995-6
Price level Price level Convergence: GDP per capita (at PPS) and price level (% of 10 core EU countries), 1995 vs Euro members Outs 70 EE- CY- MT- SI- CY-1995 70 60 50 40 30 20 EE-1995 LV-1995 LT-1995 SK-1995 LV- MT-1995 SI-1995 SK- LT- 20 30 40 50 60 70 GDP per capita PL-1995 HR-1995 RO-1995 BG-1995 BG- HU-1995 HR- RO- HU- PL- CZ-1995 Note: the 10 core EU countries are: Austria, Belgium, Denmark, Finland, France, Germany, 7 Luxembourg, Netherlands, Sweden, United Kingdom 60 50 40 30 20 20 30 40 50 60 70 GDP per capita Clear convergence, most lines are parallel CZ-
Price level (% EU core) Price level (% EU core) Price level (% EU core) Price level (% EU core) Convergence: GDP per capita (at PPS) and price level (% of 10 core EU countries), annual developments Four NMS euro members 70 65 60 55 50 45 Latvia 75.0 72.5 70.0 67.5 65.0 62.5 Malta 40 60.0 35 57.5 But annual movements not always straight 30 1995 20 25 30 35 40 45 50 55 60 65 60 55 50 Slovakia 1995 55.0 60 64 68 72 76 84 76 72 Slovenia 45 68 40 Note: the 10 core EU countries are: Austria, Belgium, Denmark, Finland, France, Germany, Luxembourg, Netherlands, Sweden, United Kingdom 35 30 1995 35 40 45 50 55 60 65 70 64 1995 60 60 64 68 72 76 8
Price level (% EU core) Price level (% EU core) Price level (% EU core) Price level (% EU core) Convergence: GDP per capita (at PPS) and price level (% of 10 core EU countries), annual developments Four NMS non-euro members 64 62 60 58 56 54 Croatia 44 40 36 32 28 Bulgaria 52 24 1995 50 20 Again, annual movements not always straight 48 1995 36 40 44 48 52 56 64 60 56 52 48 Hungary 16 20 24 28 32 36 40 44 64 60 56 52 48 Poland 44 44 Note: the 10 core EU countries are: Austria, Belgium, Denmark, Finland, France, Germany, Luxembourg, Netherlands, Sweden, United Kingdom 40 36 1995 40 44 48 52 56 60 40 36 1995 30 35 40 45 50 55 60 9
Southern euro members fate 10
Price level Convergence: GDP per capita (at PPS) and price level (% of 10 core EU countries), 1995 vs Four pre-4 EU members 100 Disappointing, even divergence in Greece and Italy 90 70 60 GR- PT- PT-1995 IT- ES- ES-1995 GR-1995 IT-1995 50 50 60 70 90 100 GDP per capita Note: the 10 core EU countries are: Austria, Belgium, Denmark, Finland, France, Germany, 11 Luxembourg, Netherlands, Sweden, United Kingdom
Price level (% EU core) Price level (% EU core) Price level (% EU core) Price level (% EU core) Convergence: GDP per capita (at PPS) and price level (% of 10 core EU countries), annual developments Four pre- 4 euro members 88 84 76 72 Greece 96 92 88 84 Italy Annual data: long and painful adjustment in Spain and Portugal Note: the 10 core EU countries are: Austria, Belgium, Denmark, Finland, France, Germany, Luxembourg, Netherlands, Sweden, United Kingdom 68 64 1995 55 60 65 70 75 85 76 74 72 Portugal 70 68 66 64 1995 63 64 65 66 67 68 69 70 71 72 76 1995 72 84 88 92 96 100 104 88 86 84 82 78 76 74 1995 Spain 72 72 74 76 78 82 84 86 88 90 12
Recent developments in new EU members 13
Quarterly GDP developments since 0 (0Q1=100) 190 1 170 Euro members Cyprus Estonia Latvia Lithuania Slovakia Slovenia Malta 190 1 170 190 1 170 Outs Bulgaria Croatia Czech Republic Hungary Poland Romania 190 1 170 150 150 150 150 130 130 130 Croatia 130 110 110 110 110 100 Note: chain-linked volumes 00 02 04 06 08 10 12 14 16 100 100 100 00 02 04 06 08 10 12 14 16 Boom & bust in some, but not all euro members 14 Long-term: no clear ranking
Employment, business sector excluding construction, real estate and agriculture (0Q1=100) 130 Euro members Cyprus Estonia Latvia Lithuania Slovakia Slovenia Malta 130 130 Outs Bulgaria Croatia Czech Republic Hungary Poland Romania 130 110 110 110 Croatia 110 100 100 100 100 90 00 02 04 06 08 10 12 14 16 No clear ranking Note: smoothed values 90 90 00 02 04 06 08 10 12 14 16 15 90
Net FDI inflow (% GDP, average 2010-16) Euro members Outs Malta 96.2 Bulgaria 2.8 Estonia 3.5 Croatia 2.3 Latvia 2.2 Hungary 2.1 Slovenia 1.4 Romania 1.9 Lithuania 1.2 Poland 1.7 Slovakia 0.8 Czech Rep. 1.5 Cyprus -7.4 No clear ranking Note: quarterly data is rather volatile, see next slide 16
Exports / imports of trading partners (0Q1=100) 240 Euro members Cyprus Estonia Latvia Lithuania Slovakia Slovenia Malta 240 240 Outs Bulgaria Croatia Czech Republic Hungary Poland Romania 240 Croatia 00 02 04 06 08 10 12 14 16 00 02 04 06 08 10 12 14 16 Fixers & floaters: quite similar (except Croatia) Note: goods and services; 41 trading partners considered, including Russia and Ukraine 17
Lessons 18
What went wrong in southern Europe? Pre-crisis problems: Interest rate fall with euro entry, but higher inflation low real interest rates unsustainable consumption & credit booms, fuelling wage growth beyond productivity growth, external imbalances & indebtedness Structurally weak fiscal positions When the crisis hit: Sudden stop in capital inflows necessitated harsh current account adjustments (though ECB helped) Strained fiscal positions necessitated procyclical fiscal tightening Painful wage falls, unemployment increases, emigration Inadequate crisis management framework of the euro area exaggerated the problem 19
Lessons from southern Europe Maastricht criteria inadequate for successful euro adoption Importance of preventing the build-up of macro vulnerabilities, like large foreign indebtedness and bank balance sheet fragility Avoid the destabilising impact of low real interest rates (macroprudential policy & counter-cyclical fiscal policy) Importance of heathy fiscal positions Importance of labour market flexibility 20
NMS: both good and bad performances in both flexible and fixed exchange rate regimes Long-run : convergence continues, despite crisisrelated adjustments, in both euro members and nonmembers Pre-crisis: bubble in fixed-rate Baltics, but also in floating rate Hungary After : Slovakia (euro) better growth and employment performance than in the Czech Republic (float) Poland (float) no recession, yet Bulgaria (fixed) mild recession and faster growth in 9-16 than in Czech Republic (float) and Hungary (float) Export market share of Poland (float) and Bulgaria (fixed) developed almost the same way New euro members so far avoided the fate of southern euro members 21
A few comments on Croatia Rather weak convergence in 1995- compared to other new EU members; long-lasting economic weakness after Yet the option of using the exchange rate to correct imbalances and absorb shocks was not used, Croatia maintained a tightly managed exchange rate Croatia is heavily euroized What s the sense of keeping an own currency when not using it? 22