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Bulgaria: Challenges of convergence to EMU

Bulgaria: Challenges of convergence to EMU. Nikolay Nenovsky University of National and World Economy Bulgarian National Bank. Topics to discus. What is convergence and why convergence is necessary? Relationships: convergence, economic cycle and monetary regime

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Bulgaria: Challenges of convergence to EMU

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  1. Bulgaria: Challenges of convergence to EMU Nikolay Nenovsky University of National and World Economy Bulgarian National Bank

  2. Topics to discus • 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

  3. Why convergence is necessary? • 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

  4. Convergence of economic cycle Sofia, UNWE - KIA, 3/05/2007

  5. Some theory and empirics of convergence • 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 Sofia, UNWE - KIA, 3/05/2007

  6. Convergence and monetary regime • Economic approach: from real economy convergence to the adoption of common currency (ex: big countries, low inflation countries, Germany) • Monetarist approach: from common currency to real convergence (ex: small countries, inflation-prone economies, South Europe, Bulgaria) • Actually: compromise (since Delors) Sofia, UNWE - KIA, 3/05/2007

  7. The basic ideas of the Monetarist approach • Common currency: strong stimulus for real convergence • 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

  8. The monetarist approach in Bulgaria: the Currency board • 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

  9. Remembering: the balance sheet of Bulgarian Central Bank Banking department Issue department Currency board Sofia, UNWE - KIA, 3/05/2007

  10. Historical remark on convergence (1)Industrialization: economic growth in Europe (%, annual) Gold standard is the best period for growth Sofia, UNWE - KIA, 3/05/2007

  11. Historical remark on convergence (2) GDP level in Europe 1913 – 2003 (%, annual), UK = 100Source: Landes, D. (2000), OECD (2005) Sofia, UNWE - KIA, 3/05/2007

  12. Some facts on convergence – real growth Sofia, UNWE - KIA, 3/05/2007

  13. Some facts on convergence – Long term interest rates Sofia, UNWE - KIA, 3/05/2007

  14. Some facts on convergence – price level Comparative price levels of final consumption by private households including indirect taxes (EU-25 = 100) Sofia, UNWE - KIA, 3/05/2007

  15. Some facts on convergence – inflation Sofia, UNWE - KIA, 3/05/2007

  16. Some facts on convergence – monetary aggregate Sofia, UNWE - KIA, 3/05/2007

  17. Some facts on convergence – credit growth Sofia, UNWE - KIA, 3/05/2007

  18. Some facts on convergence – public finance Budget surplices in last years (3.3% of GDP as end-2006) Decreasing levels of public debt (22.8% of GDP as end-2006) Sofia, UNWE - KIA, 3/05/2007

  19. Some facts of convergence – productivity GDP in Purchasing Power Standards (PPS) per person employed relative to EU-25 (EU-25 = 100) • Some preliminary conclusions from the different studies (including econometrical) on Bulgaria: • High nominal convergence (Currency board) • Low real convergence Sofia, UNWE - KIA, 3/05/2007

  20. Labor productivity per person employed GDP in Purchasing Power Standards (PPS) per person employed relative to EU-25 (EU-25 = 100) Source: Eurostat Sofia, UNWE - KIA, 3/05/2007

  21. Some problems of convergence • 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? • Who drives the convergence? • Market driven convergence • State driven convergence • The challenge of institutional convergence? • Where are the limits of European and National Institutional building? • Institutional competition • When and how to adopt the euro? Sofia, UNWE - KIA, 3/05/2007

  22. Strategies of Euro adoption • 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 • For new member states there is no opt-out clause for adoption of the single currency, the questions are “when” and “how” • 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

  23. Strategies of Euro adoption – the standard procedure Sofia, UNWE - KIA, 3/05/2007

  24. Strategies of Euro adoption:Currency board versus inflation targeting • 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

  25. Instead of Conclusion: possible sources of Bulgarian influence in EU and EMU decision making • Helen Wallace (2003) 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 • 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

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