Working Paper: CEPR ID: DP3408
Authors: Jan Babetski; Laurence Boone; Mathilde Maurel
Abstract: This Paper reviews the pros and cons of an early EU enlargement towards Central and Eastern European Countries (CEECs hereafter). First, the Maastricht criteria, which cannot be literally assessed during the catching up process, but that nevertheless mirror the huge efforts undertaken in order to (i) stabilise the economies, (ii) converge towards the EU, and then (iii) participate into the EMU, are analysed. Second, real convergence is observed to occur at different rates, depending upon the initial conditions faced and the productivity gains realised by each country. Third, computing the correlation of demand and supply shocks in a wide sample of Euro countries and the CEECs, gives some indication of the similarity of the business cycles and economic structures of the CEECs on the one hand, and the EU on the other. Yet, we argue that looking at static correlation only (averaged over the last decade) is too simplistic, as the transition process will blur these averages. Using the Kalman filter, we are able to compute time varying correlation, hence differentiating between the transition and the most recent period. Our results emphasise an ongoing process of demand shocks convergence, but supply shocks divergence. Various exchange rate strategies are then discussed.
Keywords: EU enlargement; exchange rate regimes; Kalman filter; optimal currency area criteria
JEL Codes: E32; F30; F42
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nominal convergence (O47) | real convergence (O47) |
| real convergence (O47) | sustainable economic performance (Q01) |
| demand shock convergence (F62) | economic synchronization with the EU (F15) |
| supply shocks divergence (E39) | unique structural challenges for CEECs (P29) |
| demand shocks similarity to EU (F41) | benefit of common monetary policy (E52) |
| divergence in supply shocks (E00) | need for monetary policy flexibility (E63) |
| transition process (P21) | similarity of business cycles (F44) |