Measuring OCA Criteria CNB‘s Analyses of the Economic Alignment with the Euro Area Tomáš Holub International Macroeconomics IES FSV UK, 19 April 2016

VAR analyses of macroeconomic shocks; demand and supply-side shocks identified based on imposing restrictions from the AD-AS model (Bayoumi, Eichengreen, ): Measuring OCA – Academic Approach

Bayoumi, Eichengreen (1992-3) Results

Estimates from the Early-2000s

5 A broad set of analyses prepared every year Situation in the euro area itself (since the EA crisis started) 1. Cyclical and structural alignment of the Czech Republic −real convergence; cyclical alignment; structural similarity; IR a ER convergence −trade and FDI links with the EA −financial markets similarity and integration; spontaneous euroisation 2. Alternative adjustment mechanisms in the Czech Republic −fiscal policy; wage flexibility and inflation persistence; labour market flexibility; product market flexibility; banking sector shock-absorbing capacity There is no clear sufficient / threshold level for most indicators Evolution over time and in comparison with benchmark countries: −5 “ins” similar to the Czech economy: DE, A, PT, SK, SI −2 “pre-ins” from our region: HU, PL CNB‘s Approach to Measuring OCA ments/download/analyses_of_alignment_2015.pdf

6 Benefits: Reduced Transaction Costs (AS 2014) The cost of currency conversions is % of GDP. This quantification is comparable with the transaction costs calculated for Slovakia (0.36% of GDP; NBS, 2006) and Hungary (0.11−0.22%; Csajbók and Csermely, 2002). The estimate omits a large part of the costs of exchange rate risk.

7 Trade Integration with the Euro Area

8 Heterogeneity of cyclical developments Cluster analysis (carried out by S. Benecká, 2014) documents heterogeneity of the euro area. Greece is a cluster on its own. France has fallen out of the ”core“ cluster (unlike the Czech Republic).

9 Real Convergence There is still a lot of scope for convergence in the GDP, productivity and wage levels. GDP convergence in CZ was interrupted by the crisis, but has resumed recently.

10 Price Level Convergence (i) Remember lecture 5 in our course…

11 Price Level Convergence (ii) The convergence models predict real appreciation trend in the range of 1.0–3.5% for the Czech Republic. This would imply – assuming average euro area inflation in line with the long-run forecasts (1.6%) – that inflation in the Czech Republic could increase to about 2.6–5.1% during the initial years following euro area entry.

12 Cyclical alignment (i) The cycle has become much more synchronized since the crisis started. Is this synchronization permanent, or does it only reflect temporary incidence of extraordinarily strong international shocks?

13 Cyclical alignment (ii)

14 Cyclical alignment (iii) The correlation has increased since 2008 to relatively high levels.

15 Cyclical alignment (iv) The correlation at business cycle frequencies has been very high since 2008.

16 Correlation of Macroeconomic Shocks The Bayoumi-Eichengreen approach was for the last time used in the 2012 edition of the Analysis of alignment. It identified increased correlation of supply-side shocks, with no correlation of demand shocks. However, this is because the contraction in economic activity during the crisis – given its long duration – was interpreted in the analysis as a supply shock (whereas in reality it was largely a significant demand shock).

17 Structural Similarity CZ has a high share of industry in GDP, mainly in highly-cyclical goods (cars, electronics, machinery).

18 Fiscal Policy Persistent deficits caused by structural factors (Maastricht limit has been reached, but divergence from MTO planned in ) Often pro-cyclical discretionary measures High share of mandatory expenditure + ageing problem

19 Labour Market Flexibility Czech NAIRU is quite low by the (soft) European standards. Flexibility has increased in terms of using part-time jobs. But: low mobility of labour force, high regional differences, space for improvement in the institutional framework, disincentives to searching for new jobs, etc.

20 Summary and Conclusions Euro adoption is a political decision. But the decision should take into account the economic analysis (prepared every year by the CNB and the Ministry of Finance). High degree of trade integration is the main argument in favour of euro. Problems in the EA as a new factor to consider since the crisis started. Domestic fiscal situation is no more an obstacle to meeting the Maastricht criteria, but MTO has not been reached on a durable basis. Several elements of economic misalignment with the EA prevail. Major problems are in the low level of: economic convergence, labour market flexibility and long term ability of the fiscal policy to serve as a macro stabilizer.

21 Thank you for your attention Tomáš Holub