Transcript Convergence and shocks in the road to EU: Empirical investigations

Bulgaria:
Challenges of convergence to EMU
Nikolay Nenovsky
University of National and World Economy
Bulgarian National Bank
Topics to discus
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What is convergence and why convergence is
necessary?
Relationships: convergence, economic cycle and
monetary regime
Two historical remarks on convergence
Some theory of convergence
Bulgaria: some facts of convergence
Bulgaria: some problems of convergence
Sofia, UNWE - KIA, 3/05/2007
Why convergence is necessary?
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Convergence: process according to which the differences
between countries' main characteristics become smaller
and eventually disappear with the time …
Why convergence?
 Readiness to adopt common monetary policy (ECB) and
common currency (Euro)
 Synchronization of economic cycle, catch-up EU
 Similar transmission channels of Monetary policy
 Similar reaction to EU shocks
 Appropriate mechanisms of shocks absorption
(openness, flexible markets, free movement of goods, K,
L, budget transfers etc.)
Sofia, UNWE - KIA, 3/05/2007
Convergence of economic cycle
Bad synchronization
Good synchronization
GDP
GDP
BG
EU
BG
i?
EU
i↑
i↓
Sofia, UNWE - KIA, 3/05/2007
Some theory and empirics of convergence
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Maastricht criteria (static) (ST: inflation, public deficit, exchange rate;
LT: public debt, long term interest rate)
Econometric measuring (dynamic) of convergence:
 convergence (the variable of the poorer country advance faster that of richer
country and catch-up with them)
 convergence (means dispersion between the variables in the rich and the poor
countries decreases with time)
Conditional convergence: local (versus absolute)
absolute
local
GDP
GDP
A
A
B
B
t
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t
Convergence and monetary regime
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Economic approach: from real economy
convergence to the adoption of common currency
(ex: big countries, low inflation countries, Germany)
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Monetarist approach: from common currency to
real convergence
(ex: small countries, inflation-prone economies, South
Europe, Bulgaria)
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Actually: compromise (since Delors)
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The basic ideas of the Monetarist approach
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Common currency: strong stimulus for real
convergence
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Stimulate real convergence via trade integration
(endogenous currency area)
Transaction cost reduction, Exchange rate risk
elimination, low interest rates, high investment etc.
Low probability of twin crisis
Help to build hard budget constraints, “culture of
discipline” and higher credibility
External monetary anchor for small open economy
Sofia, UNWE - KIA, 3/05/2007
The monetarist approach in Bulgaria:
the Currency board
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Institutional solution after the crisis (1997)
Exchange rate fixed by low (since 1997)
Full coverage of monetary base (imitation of the
gold standard, automatic mechanism etc.)
Limited monetary policy tools (RR) and limited
LLR
High transparency, credibility and discipline
Quasi Euro area – import ECB monetary policy
Sofia, UNWE - KIA, 3/05/2007
Remembering: the balance sheet of Bulgarian Central Bank
Banking department
Issue department
Currency board
ASSETS
Cash
Monetary gold
Foreign securities
LIABILITIES
Currency in circulation
Bank deposits
(R = RR+RE)
Government deposits
and accounts
(Fiscal reserve)
Banking Department
deposit
(Net value of Currency
board)
Total 8.6 b euro
ASSETS
LIABILITIES
Non monetary gold and other
precious metals
Borrowings from IMF
Investment in securities
Liabilities to other
international financial
institutions
Loans and advances to banks
Capital
Claims on government
Reserves
Bulgarian’s IMF quota and
holdings
in other international financial
institutions
Retained profit
Deposit with Issue Department
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Historical remark on convergence (1)
Industrialization: economic growth in Europe
(%, annual)
Gold standard is the best period for growth
Western
Europe
South
Europe
Oriental
Europe
GDP
1820–1870
1.7
1.0
0.6
1870–1913
2.1
1.5
2.4
Population
1820–1870
0.7
0.3
0.9
1870–1913
0.7
0.4
1.3
GDP per capita
1820–1870
1.0
0.6
0.7
1870–1913
1.3
1.1
1.0
[1870–1910]
1.2
0.9
1.4
Source: A. Maddison (1995), Good D., T. Ma (1999)
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Historical remark on convergence (2)
GDP level in Europe 1913 – 2003
(%, annual), UK = 100
Source: Landes, D. (2000), OECD (2005)
Russie
Bulgarie
Portugal
Grèce
Hongrie
Finlande
PIB (2003)
PIB (1913)
Espagne
Italie
Irlande
Autriche
Norvège
Suède
Pays-Bas
Allemangne
Danemark
Suisse
France
Belgique
Grande-Bretagne
0
25
50
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75
100
125
Some facts on convergence – real growth
7
6
per cent
5
4
3
2
1
0
2000 2001 2002 2003 2004 2005 2006 2007 2008
(f)
(f)
EU-25
Bulgaria
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Some facts on convergence –
Long term interest rates
9
per cent
8
7
Reference Value
Bulgaria
6
5
4
3
2002
2003
2004
2005
2006
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Some facts on convergence – price level
43
42
41
40
39
38
37
36
35
2000
2001
2002
2003
2004*
2005
Comparative price levels of final consumption by private households including indirect
taxes (EU-25 = 100)
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Some facts on convergence – inflation
20
10
5
0
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
per cent
15
Bulgaria
Bulgaria (underline inflation)*
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Reference Value
Some facts on convergence – monetary
aggregate
30%
25%
%
20%
15%
10%
5%
0%
2001
2002
2003
M3 (growth rates) - Euro area
2004
2005
M3 (growth rates) - Bulgaria
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2006
Some facts on convergence – credit growth
60%
50%
%
40%
30%
20%
10%
0%
2001
2002
2003
2004
2005
Claims on non-government sector (growth rates) - Euro area
Claims on non-government sector (growth rates) - Bulgaria
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2006
Some facts on convergence – public finance
ЕС-25
Bulgaria
Reference value
4
3
Budget surplices in last years
(3.3%
of GD
P as end-2 006)
2
%
1
0
-1
2000
2001
2002
2003
2004
2005
2006e
2007e
-2
-3
-4
Decreasing levels of public
debt(2 2 .8%
of GD
P as end2006)
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Some facts of convergence – productivity
GDP in Purchasing Power Standards (PPS) per person employed
relative to EU-25 (EU-25 = 100)
37
36
35
34
33
32
31
30
29
28
2000
2001
2002
2003 2004f 2005f 2006f 2007f 2008f
• Some preliminary conclusions from the different studies
(including econometrical) on Bulgaria:
High nominal convergence( Currency board)
Low real convergence
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Labor productivity per person
employed
37
36
35
34
33
32
31
30
29
28
2000
2001
2002
2003
2004f 2005f 2006f 2007f 2008f
GDP in Purchasing Power Standards (PPS) per person employed relative to
EU-25 (EU-25 = 100)
Source: Eurostat
Sofia, UNWE - KIA, 3/05/2007
Some problems of convergence
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Convergence and development – enemies or friends?
 Does poor countries( catch-up countries) need the same cycle
and the same institutions like in the rich countries?
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Who drives the convergence?
 Market driven convergence
 State driven convergence
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The challenge of institutional convergence?
 Where are the limits of European and National Institutional
building?
 Institutional competition
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When and how to adopt the euro?
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Strategies of Euro adoption
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Bulgaria was committed to join ERM II immediately after the date of
EU membership, We intend to enter ERM II at current exchange rate –
1.95583 BGN for 1 Euro
Bulgarian authorities unilaterally commit to keep currency board until
Euro area membership
Council of Ministers commits to follow balanced budget policy and to
respect SGP principles
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For new member states there is no opt-out clause for adoption of the
single currency, the questions are “when” and “how”
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Now - decisions to take: the date of entry, the choice of the central rate,
the width of the exchange rate band, the length of stay in the mechanism
etc – from our point of view is clear.
Sofia, UNWE - KIA, 3/05/2007
Strategies of Euro adoption – the standard procedure
Scenario 1
ERM II
EMU
Scenario 2
06/2007
transition
COMECOM
ERM II
EU
1989
Scenario 3
ERM II
EMU
06/2007
06/2009
01/2007
+/- 15%
Min 2 year no devaluation
Maastricht criteria
Ex rate is of common interest
(all kinds of preliminary Euroization
are almost impossible)
Sofia, UNWE - KIA, 3/05/2007
EMU
Strategies of Euro adoption:
Currency board versus inflation targeting
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Inflation targeting needs Central bank credibility
Need for good knowledge of the transmission mechanism
and good macroeconomic model
Need for well defined loss function (output gap) and
reaction function (Taylor rule for example)
Need for good inflation forecasts (EE never hit the target)
Need for very good macro econometric model
Need for developed financial markets
None of these conditions exists in Bulgaria, Romania or
Eastern Europe in general
Sofia, UNWE - KIA, 3/05/2007
Instead of Conclusion: possible sources of Bulgarian
influence in EU and EMU decision making
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Helen Wallace(2 0 0 3) methodology 7 sources of influence:
 Political weight( non)
 Economic weight( non)
 Political practice( yes) ?
 Social and economic practice( yes) ?
 Persuasive ideas( yes) ?
 Compelling demands( yes) ?
 Credibility and consistency( yes) – Currency board, fiscal discipline
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Bulgaria should take the example of the Benelux countries
 Currency board, fiscal discipline
 Policy entrepreneur
 Persuasive ideas
 Pace-setting role
Sofia, UNWE - KIA, 3/05/2007