Exchange Rate Regimes In Central Eastern And Southeastern Europe

There are 13 countries in Central, Eastern and Southeastern Europe (CESEE) with floating exchange rate regimes, de jure. This paper uses the framework pioneered by Frankel and Wei (1994) and extended in Frankel and Wei (2008) to show that most of them have been tracking either the euro or the US dollar in recent years. Eight countries, all of them current or aspiring EU members, track the euro. Of the five countries keying on the US dollar in various degrees, all but one belong to the Commonwealth of Independent States. The paper shows that the extent to which each country’s currency tracks the euro (or the dollar) is correlated with the structure of its external trade and finance. However, some countries appear to track the EUR or USD to an extent which appears inconsistent with inflation targeting, trade or financial integration, or the extent of business cycle synchronization. The phenomenon is particularly pronounced among the countries in the CESEE euro bloc, which may be deliberately gravitating around the euro in anticipation of eventually joining the Euro Area.

There are 13 countries in Central, Eastern and Southeastern Europe (CESEE) with floating exchange rate regimes, de jure. This paper uses the framework pioneered by Frankel and Wei (1994) and extended in Frankel and Wei (2008) to show that most of them have been tracking either the euro or the US dollar in recent years. Eight countries, all of them current or aspiring EU members, track the euro. Of the five countries keying on the US dollar in various degrees, all but one belong to the Commonwealth of Independent States. The paper shows that the extent to which each country's currency tracks the euro (or the dollar) is correlated with the structure of its external trade and finance. However, some countries appear to track the EUR or USD to an extent which appears inconsistent with inflation targeting, trade or financial integration, or the extent of business cycle synchronization. The phenomenon is particularly pronounced among the countries in the CESEE euro bloc, which may be deliberately gravitating around the euro in anticipation of eventually joining the Euro Area.

The more advanced Central and Eastern European Countries (CEECs) face an evolving set of considerations in choosing their exchange rate policies. On the one hand, capital mobility is increasing, and this imposes additional constraints on fixed exchange rate regimes, while trend real appreciation makes the combination of low inflation and exchange rate stability problematic. On the other hand, the objectives of EU and eventual EMU membership make attractive a peg to the euro at some stage in the transition. The paper discusses these conflicting considerations, and considers the feasibility of an alternative monetary framework, inflation targeting.

This paper examines the relationship between the exchange rate regime and the pace of current account adjustment. The panel data set we refer to includes 11 catching-up countries from central, eastern and south-eastern Europe between 1994 and 2007. The exchange rate regime is measured by a continuous z-score measure of exchange rate volatility proposed by Gosh, Gulde and Wolf (2003). Based on a basic autoregression estimation, the results indicate that a more flexible exchange rate regime significantly enhances the rate of current account adjustment.

The upcoming enlargement of the European Monetary Union involves the selection of appropriate reference rates at which the exchange rates of the accession countries will be fixed against the euro in order to avoid economic distortions as consequences of serious exchange rate misalignments. Determination of an exchange rate that is neither undervalued nor overvalued raises the issue of equilibrium exchange rates. Based on time series as well as panel estimation techniques three different concepts - BEER, PEER and PPP - are applied in this study to calculate equilibrium exchange rate levels for ten Central and Eastern European countries. The results indicate significant real misalignments in a number of accession countries.