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The Eesti Pank Expreience in the ERM-II

This document outlines the insights from the Eesti Pank regarding Estonia's participation in the European Exchange Rate Mechanism II (ERM-II). It discusses the historical context of fixed exchange rate arrangements, the public's expectations, and the steps leading to EU accession. The economic implications of ERM-II are analyzed, highlighting low interest rates, growth boosts in investment and productivity, and the minimal direct impact on capital flows. The conclusion emphasizes the importance of fundamental economic factors over ERM-II itself in shaping Estonia's financial landscape.

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The Eesti Pank Expreience in the ERM-II

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  1. The Eesti Pank Expreience in the ERM-II Märten Ross Eesti Pank October 3rd, 2005, Sofia

  2. Background • Fixed exchange rate arrangement for ‘who knows how many years’ • Public expectations, transmission mechanism • Inflation well-checked • Perception of ‘already a currency union’ • ERM-II entry close to EU entry: any economic imlplications interconnected • Some global factors more important than ERM-II decision

  3. 7 12 DEM LIBOR (later EURIBOR) and EST TALIBOR spread A/positive 6 5,9 A-/positive 10 5 A-/stable 8 4,2 4 BBB+/positive 6 “Yes” in EU referendum 3 BBB+/stable 4 Most “easier” chapters were closed Commission published detailed timetable for negotiations 2 1,6 1,2 2 1,3 1 Invitation to negotiations 0,5 0,3 0,8 0,3 0,5 0 Feb 96 Dec 96 Sept97 July 98 May 99 Mar 00 Jan 01 Nov01 Sept02 June 03 Jan 04 Nov04 Jan 05 Estonia’s credit rating* and EU accession * - Estonia’s LT debt rating by Standard&Poor’s

  4. Inflation differential with euro zone well within “Balassa-Samuelson limits”

  5. About the entry • Pre-entry discussions very serious (‘good peer pressure’, but little knowledge of currency board) • Some dispute about its rationale • Complications in communication • How to communicate XR policy without XR? • is it a waiting room? • Entry itself was non-event for public • Estonian press reps in Brussels even did not notice it! And rightly so.

  6. About the life within the ERM II • So far no pressures whatsoever • Has not done at least any harm: PR of XR policies has become even easier • More squeezing from partners (‘good peer pressure – now for double’) • Minor additional technical responsibilities • Participation often taken de facto as a ‘waiting room’

  7. Interest rates have remained low

  8. About the economic implications • EU (ERM-II?) has been even bigger boost for growth, investment and productivity than expected • EU entry had technical implications for inflation – reasons difficult to communicate! • ERM II per se has not probably caused major capital flows • If ERM II entry is credibility enhancing and connected to euro entry expectations, then it adds to the demand pressure – it’s unavoidable and not necessarily bad

  9. Has potential changed?

  10. Food & Fuel: CPI components influenced by EU entry technicalities

  11. Capital flows influenced by underlying factors rather than ERM-II

  12. Conclusions • ERM II should not be overmystified • Its direct economic impact can be limited • It is not yet currency union • However, ERM II has not been also as harmful as some commentators predicted. Fundamentals are more important.

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