Jaromír Šindel ECES Monetary or Exchange Rate Based Stabilization Programme The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Topics Exchange rate and transition –Devaulation, appreaciation trends,... Nominal and Real Exchange Rate –Inflation differentials, exchange rate arrangements Exchange rate and Interest Groups –Competitiveness, … The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Exchange rate regime classification Floating rate regimes –Floating rate with inflation targeting –Managed exchange rates without explicit targets (“dirty float”) –Pure floating rates: No CB intervention Fixed-rate regimes –Soft pegs: Explicit targets without full monetary adjustment –Exchange rate bands and target zones –Crawling pegs, corridors, and tabilias –Use of sterilized intervention –Hard pegs: Full use of automatic monetary adjustment –Currency unions –“Dollarization” –Currency boards The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Exchange rate regime classification The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Source: Holub, T.: Foreign Exchange Interventions Under Inflation Targeting: The Czech Experience. ČNB (2004).

Exchange rate and transition The theoretical paths of the real exchange rate in transitional economies The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Source: Frait, Komárek (1998)

Why RER appreciation? a)Improvement in the terms of trade –Exporters and domestic producers improve the quality of their products. b)Wages in the non-tradable good sectors rise relative to wages in the traded good sector are lower than those ones in the traditional industry-based tradable good sector. c)Initially wages far exceed productivity in the traded good sector –therefore the subsequent correction of these imbalances leads to a real appreciation as prices in nontradable goods absorb the rise in costs. d)The Ballasa and Samuelson effect. The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Different Currencies The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague CountryCurrencyCountryCurrency Czech Republic koruna Estonia kroon Slovakia koruna Latvia lats Poland zloty Lithunia litas Hungary forint Bulgaria lev Slovenia tolar Romania new leu Croatia kuna France euro USA dollar Germany euro United Kingdom pound Switzerland franc Monte Negro euro

Exchange rate and transition Source: Kočenda (1998) Monetary Regimes in the C&EE till 1997 The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Different Currencies The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague CountryCurrencyCountryCurrency Czech Republic koruna Estonia kroon Slovakia koruna Latvia lats Poland zloty Lithunia litas Hungary forint Bulgaria lev Slovenia tolar Romania new leu Croatia kuna France euro USA dollar Germany euro United Kingdom pound Switzerland franc Monte Negro euro

Nominal and Real ER of C&EE Currencies against Germany Mark The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Nominal Czech republic Real Source: Kočenda (1998)

Nominal and Real ER of C&EE Currencies against Germany Mark The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Nominal Hungary Real Source: Kočenda (1998)

Nominal and Real ER of C&EE Currencies against Germany Mark The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Nominal Slovakia Real Source: Kočenda (1998)

Nominal and Real ER of C&EE Currencies against Germany Mark The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Nominal Poland Real Source: Kočenda (1998)

Exchange rate and transition Source: Frait, Komárek (1998) Alternative exchange rate scenarios The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Inflation differentials, nominal and real ER of the CEE countries The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Czech Republic Slovakia Source: Frait, Komárek (1998)

Inflation differentials, nominal and real ER of the CEE countries The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Hungary Poland Source: Frait, Komárek (1998)

Inflation differentials, nominal and real ER of the CEE countries The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Estonia Slovenia Source: Frait, Komárek (1998)

Following Generalisations about ER Path in Transition a) Significant nominal exchange rate depreciation - the exchange rate flexibility at the beginning of the 1990s - Slovenia, Hungary, Poland. b) fixed exchange rate - lower inflation (The Czech Republic, Slovakia, Estonia). c) A trend towards real appreciation can be found in all accession countries, even though with profound differences. The strongest one is confirmed in Estonia and significantly applies also to the Czech Republic, Poland and Slovakia. On the other hand, Hungary and Slovenia experienced only mild real appreciation. –Real appreciation in Czech R. (Inflation differential) x Poland (inflation caused by devaluation) d) convergence process - slow e) Since switch from nominal exchange rate depreciation to nominal exchange rate stability or even appreciation The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Source: Frait, Komárek (1998)

Interest Groups and Exchange Rate Development Consumers – imported goods (appreciation) x wages (competitiveness - depreciation); foreign assets (depreciation) x foreign debt (depreciation ) Government – foreign debt + foreign bonds (appreciation) x privatisation (not appreciation) Exporters - competitiveness (depreciation) x ? Share of imported goods; Dual Economy? Importers – appreciation Domestic Firms – not appreciation (competitiveness against importers) Foreign Investors – privatisation (depreciation) x assets (appreciation) Multinational Corporation – stable ER, appreciation (if Czech firms are suppliers) The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Competitiveness and ER appreciation – how to cope with it? Improve image and export at a higher price Increase labour productivity at constant wages Pay lower wages at unchanged productivity Shift from domestic production to more import Shift production to another country Exert political pressure against appreciation The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Exchange Rate in CR? Who is Winner and who is Looser The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Development of the Czech Crown Source: Holub, T.: Foreign Exchange Interventions Under Inflation Targeting: The Czech Experience. ČNB (2004).

Impossible Trinity Fixed ER + Free Foreign Capital + Inflation (Interest Rates) … IRtr - IReu = appreciation of tr´ currency ? floating + inflation targeting – you can not allowed depreciation for increase the competitiveness The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague

Lessons for future. The Puzzles of Central and Eastern Europe Transformation and Integration ECES, Prague Design exchange rate arrangements for Cuba and China. Goals, solutions, reasons, impact on interest groups.