1. Section 4. Adjustment within the euro area References: 1. The 2006 EU Economy Review: adjustment dynamics in the euro area 2. Bruegel Policy No. 3 3. P. Lane, “The Real Effects of EMU”, IIIS Discussion Paper No. 115 4. Ahearne, Schmitz and von Hagen (2007)

2. Preliminaries Real effective exchange rate Real effective exchange rate Real GDP growth and contributions Real GDP growth and contributions The “competitiveness” channel of adjustment The “competitiveness” channel of adjustment The “real interest rate” channel of adjustment The “real interest rate” channel of adjustment

3. Inflation

4. Long-term interest rates

5. Euro-dollar

6. GDP growth

7. Average GDP growth

8. Employment rate

9. Labour productivity

10. Relative export performance

11. Bruegel policy brief 3 What are the policy implications for current members? What are the policy implications for current members? What are the policy implications for new EMU applicants? What are the policy implications for new EMU applicants?

13. Policy implications for current members Make sure divergence does not get any worse Make sure divergence does not get any worse Boost the “competitiveness channel” Boost the “competitiveness channel” Don’t do procyclical fiscal policy Don’t do procyclical fiscal policy Enhance prudential and regulatory policies Enhance prudential and regulatory policies

14. Race to the euro CountryEUERM II Euro Official Date Slovenia2004 2007 Cyprus200420052008 Malta200420052008 Slovakia200420052009 Bulgaria2007n. a. Czech Republic20042008*2011* Estonia2004 2010** Hungary20042011*2014* Latvia200420052008** Lithuania2004 2010*** Poland20042009*2012* Romania2007n. a.

15. Maastricht criteria Price stability criterion: inflation does not exceed by more than 1½ percentage points that of the three best-performing EU members Price stability criterion: inflation does not exceed by more than 1½ percentage points that of the three best-performing EU members The exchange rate criterion: requires the observance of the normal fluctuation margins of the exchange rate mechanism (ERM II) for at least two years without severe tensions The exchange rate criterion: requires the observance of the normal fluctuation margins of the exchange rate mechanism (ERM II) for at least two years without severe tensions

16. Maastricht criteria Long-run interest rate criterion: nominal interest rate do not exceed by more than 2 percentage points that of the three best- performing EU members Long-run interest rate criterion: nominal interest rate do not exceed by more than 2 percentage points that of the three best- performing EU members General government budget deficit must not exceed 3 percent of GDP; Gross government debt must not exceed 60 percent of GDP. General government budget deficit must not exceed 3 percent of GDP; Gross government debt must not exceed 60 percent of GDP.

17. GDP growth

18. Implications for new EMU applicants Maastricht criteria might be too strict (Balassa-Samuelson) Maastricht criteria might be too strict (Balassa-Samuelson)