EXCHANGE-RATE REGIMEAND RESPONSE TO THE CRISIS

IN THE EU NEW MEMBER STATES

KALIN HRISTOV

OUTLINE

• CONVENTIONAL VIEW ON EXCHANGE RATE REGIMES AND COMPETITIVENESS

• DEVELOPMENTS IN PRICE BASED MEASURES OF COMPETITIVENESS – ULC, REER

• VALIDITY OF CONVENTIONAL VIEW IN PRACTICE

• EXPERIENCE DURING THE RECENT CRISIS – EXCHANGE RATE DEVELOPMENTS, EXPORT PERFORMANCE, GROWTH AND INFLATION

CONVENTIONAL VIEW EXCHANGE RATE AND COMPETITIVENESS

• There is a conventional view that exchange rate flexibility allows a conduct of a countercyclical monetary policy and provides short term competitive advantage. This view is based on a number of assumptions:– Law of one price holds – Exchange rate pass-through (ERPT) is low– No balance sheet (BS) effects ( no borrowing and saving

in foreign currency)– Low bargaining power of the labor unions– Marshall-Lerner condition holds– No “fear of floating” or “fear of losing international

reserves”

DEVELOPMENTS IN COMPETITIVENESS– ULC

• EU NMS experience a process of deepening trade and financial integration and rapid nominal and real convergence. This is reflected in ULC and REER developments

• The dynamics of ULC in the EU NMS shows two common trends: – the nominal convergence with EU 15 is related

to an increase in prices and wages which is reflected in a steady increase in nominal ULC before the crisis

– competitiveness is however maintained which is reflected in the relatively stable real ULC for the majority of the countries

NOMINAL ULC IN NATIONAL CURRENCY, 2000=100 (four-quarter moving average)

50

100

150

200

250

300

350

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: ECB

Note: in descending order as of 2009:q2

50

100

150

200

250

300

350

Romania Latvia Bulgaria Hungary Lithuania

Slovenia Slovakia Czech Republic Poland Estonia

NOMINAL UNIT LABOR COST IN EURO2000=100

80

100

120

140

160

180

200

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

80

100

120

140

160

180

200

Romania Estonia Czech Republic Latvia SlovakiaHungary Lithuania Slovenia Poland Bulgaria

Source: European Commission, AMECO database, last update: 22 Apr 2009

Note: in descending order as of 2008. EC forecast for 2009

REAL UNIT LABOR COST 2000=100

80

85

90

95

100

105

110

115

120

125

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

80

85

90

95

100

105

110

115

120

125

Estonia Latvia Lithuania Hungary Bulgaria

Slovenia Slovakia Romania Poland Czech RepublicSource: European Commission, AMECO database, last update: 22 Apr 2009

Note: in descending order as of 2008. EC forecast for 2009

DEVELOPMENTS IN COMPETITIVENESS – REER

• The dynamics of the real effective exchange rate based on nominal ULC shows trend of gradual increase during the last ten years in all EU new member countries which is due to the process of nominal and real convergence

• The appreciation reflects productivity gains in these countries

• Reflecting predominantly equilibrium trend appreciation the rise in REER does not erode competitiveness

REAL EFFECTIVE EXCHANGE RATE, ULC BASED, 1999=100

80

100

120

140

160

180

200

220

240

01'99 01'00 01'01 01'02 01'03 01'04 01'05 01'06 01'07 01'08

80

100

120

140

160

180

200

220

240

Romania Slovakia Latvia Hungary Estonia

Lithuania Bulgaria Poland Slovenia Czech RepSource: European Commission, Price and Cost Competitiveness, May 2009

Note: in descending order as of 2008:q4. The REER index for each of the countries is calculated relative to a basket of 36

industrial countries.

LABOR PRODUCTIVITY DIFFERENTIALS BETWEEN NMS and EU15

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: European Commission, AMECO database, last update: 22 Apr 2009Note: in descending order as of 2008. EC forecast for 2009

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

Romania Lithuania Slovakia Czech RepublicHungary Poland Slovenia EstoniaLatvia Bulgaria

VALIDITY OF CONVENTIONAL VIEW IN PRACTICE

• The assumptions of the traditional view are rarely met in practice:– EU NMS are small open economies with free capital

mobility and trade

– Their recent development has been influenced by large capital inflows

– High level of euroisation (credit, deposits) which implies big balance sheet effects

– NMS’ exporters have low international pricing power

– The impacts of the ERPT, BS effects, labor unions and Marshall-Lerner condition vary across EU NMS

• Hence, competitiveness implications of ER regime are not straightforward (contrary to the traditional view)

EXPERIENCE DURING THE RECENT CRISIS – EXCHANGE RATE DEVELOPMENTS

• Is the view of a higher vulnerability of the fixed exchange rate regime supported by the latest empirical data?

• Do countries with flexible exchange rate which potentially can allow depreciation of their exchange rate have better export performance during the current crisis?

• Is the division between countries with fixed and flexible exchange rate regime relevant during the current crisis?

EXPERIENCE DURING THE RECENT CRISIS – REAL

ACTIVITY AND EXPORT PERFORMANCE • GDP and unemployment developments as well

as export dynamics in euro follow similar patterns across countries (although magnitudes vary)

• The exchange rate regime (fixed or flexible) not a dividing characteristic

• Trade is shrinking in all countries (having fixed or flexible exchange rate) because of the common shock – decrease of the volume of the world trade

GDP REAL GROWTH RATES , y-o-y (%)

-25

-20

-15

-10

-5

0

5

10

15

q1'07 q2'07 q3'07 q4'07 q1'08 q2'08 q3'08 q4'08 q1'09 q2'09

-25

-20

-15

-10

-5

0

5

10

15

Poland Bulgaria Czech Republic SlovakiaRomania Slovenia Estonia LithuaniaLatvia Hungary

Source: Eurostat

Note: in descending order as of 2009:H1

GDP GROWTH RATES

-25

-20

-15

-10

-5

0

5

10

2008 2009f

%

BULGARIA CZECH REP. ESTONIA HUNGARY LATVIA LITHUANIA POLAND ROMANIA

FISCAL POSITION

-8

-7

-6

-5

-4

-3

-2

-1

0

1

2

2008 2009f

% o

f G

DP

BULGARIA CZECH REP. ESTONIA HUNGARY LATVIA LITHUANIA POLAND ROMANIA

CURRENT ACCOUNT

-30

-25

-20

-15

-10

-5

0

5

10

2008 2009f

% o

f G

DP

BULGARIA CZECH REP. ESTONIA HUNGARY LATVIA LITHUANIA POLAND ROMANIA

UNEMPLOYMENT RATES, seasonally adjusted (%)

2

4

6

8

10

12

14

16

18Ja

n-0

8

Feb

-08

Mar

-08

Apr

-08

May

-08

Jun

-08

Jul-

08

Au

g-08

Sep

-08

Oct

-08

Nov

-08

Dec

-08

Jan

-09

Feb

-09

Mar

-09

Apr

-09

May

-09

Jun

-09

Jul-

09

2

4

6

8

10

12

14

16

18

Latvia Lithuania Estonia Slovakia Poland

Bulgaria Czech Republic Slovenia Romania HungarySource: Eurostat

Note: in descending order as of the last 3 months

SHARE OF EXPORT OF GOODS IN WORLD EXPORT, 1999=100

50

100

150

200

250

300

350

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

50

100

150

200

250

300

350

Lithuania Slovakia Poland LatviaRomania Bulgaria Czech Republic EstoniaHungary Slovenia

Source: European Commission, AMECO database, last update: 22 April 2009

Note: in descending order as of 2008. EC forecast for 2009-2010

100

120

140

160

180

200

220

240

q1'02 q3'02 q1'03 q3'03 q1'04q3'04 q1'05 q3'05 q1'06 q3'06q1'07 q3'07 q1'08 q3'08 q1'09

100

120

140

160

180

200

220

240

Slovakia Lithuania Romania BulgariaCzech Republic Hungary Slovenia LatviaEstonia Poland

EXPORT SHARES of EU NMS in EU27 IMPORTS

(annualized index, 2000=100)

Source: Eurostat,BNB

Note: in descending order as of 2009:q2

-40

-30

-20

-10

0

10

20

30

40

01'07 04'07 07'07 10'07 01'08 04'08 07'08 10'08 01'09 04'09 07'09

%

-40

-30

-20

-10

0

10

20

30

40

%

Hungary Poland Slovenia Estonia Bulgaria

Czech Republic Slovakia Latvia Lithuania Romania

Source: Eurostat, BNB

Note: in descending order as of J uly 2009

(annual growth, 3-month moving average in %)

EXPORTS of EU NMS in EURO

EXCHANGE RATE FLEXIBILITY AND COMPETITIVENESS – RECENT EXPERIENCE

• Possible reasons for the failure of the nominal exchange rate depreciation to improve competitiveness:– depreciation leads to more expensive imports (imports

of raw materials and investment goods), thus increases costs of production

– depreciation increases the inflation rate which pushes up wages

– depreciation leads to balance sheet effects and increases cost of financing for the corporate sector

– External demand is depressed

ANNUAL HICP INFLATION

-5

0

5

10

15

20

2001 2002 2003 2004 2005 2006 2007 2008 2009

%

-5

0

5

10

15

20

%

Romania Poland Lithuania Latvia Bulgaria

Slovakia Czech Republic Slovenia Estonia Hungary

Source: EurostatNote: in descending order as of the latest three months

EXCHANGE RATE DEVELOPMENTS

-50

-45

-40

-35

-30

-25

-20

-15

-10

-5

0

5

1001/09/2008

11/09/2008

21/09/2008

01/10/2008

11/10/2008

21/10/2008

31/10/2008

10/11/2008

20/11/2008

30/11/2008

10/12/2008

20/12/2008

30/12/2008

09/01/2009

19/01/2009

29/01/2009

08/02/2009

18/02/2009

28/02/2009

10/03/2009

20/03/2009

30/03/2009

09/04/2009

19/04/2009

29/04/2009

09/05/2009

19/05/2009

29/05/2009

08/06/2009

18/06/2009

28/06/2009

08/07/2009

18/07/2009

28/07/2009

07/08/2009

17/08/2009

27/08/2009

06/09/2009

16/09/2009

26/09/2009

06/10/2009

%

-50

-45

-40

-35

-30

-25

-20

-15

-10

-5

0

5

10

%

EUR-RON X-RATE EUR-PLN X-RATE EUR-CZK X-RATE EUR-HUF X-RATE

Accumulated Development, Sept '08 - Mar '09

Poland

Hungary

Czech Republic

Romania

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

0% 5% 10% 15% 20% 25% 30% 35% 40%

Exchange rate depreciation

Inflati

on

Source: ECB, BNB

EXCHANGE RATE REGIME AND MONETARY CONDITIONS DURING THE RECENT CRISIS

• The choice of an exchange rate regime cannot unequivocally be associated with advantages or disadvantages

• Problems of the autonomous monetary policy’s capabilities during the crisis:– Transmission of the conducted monetary policy

is limited

– Pursuing multiple domestic economic objectives is difficult

– Asymmetric autonomy (“Yes” in “good times”, “No” in “bad times”)