William Davidson Institute Working Paper 402
I. Introduction
In Helsinki, in December 1999, Southeast European countries like Bulgaria
and Romania were invited to start admission negotiations with the European Union.
Although an official accession date has not yet been decided, a realistic forecast
would set it around the year 2010. By this date they will face the monetary integration
challenge, a process that may last a few more years. In the current decade, these
countries should undertake important structural transformations in order to set their
economies in line with Western ones. Fast integration requires the fulfilment of a set
of social, political and economic criteria. Essential economic criteria are a low
inflation rate, low public debt and deficits, low interest rates and a stable currency
against the Euro. Less explicit, but also very important, these countries should reduce
gaps vis-à-vis the Western partners, in order to be able to comply with obligations
related to the participation to the Western club. A relatively high GDP per head is by
all means the best ticket to entry.
Unfortunately, given a limited number of instruments and resources, these
goals may sometimes be conflicting and policy choices should take into account the
trade-off between them. Also, during the decade, the relative importance of the
various objectives may change and would require an adjustment of policies and
mechanisms.
In most developed countries, the management of monetary parameters and the
exchange rate is the responsibility of central banks. Sometimes the central bank
determines on its own the policy objectives to be achieved, some other times the
government has a say in this process. Following the Fed example, in the last twenty
years, all developed countries have endowed their central bankers with powerful tools
that allow them to control the key variables in the money market. This was the full
truth about setting “independent” central banks: not only to give central banks
political independence, but also to cut any direct link between state deficits and
monetary base. The significant progress of the Western world in the fight against
inflation can be attributed to a large extent to the implementation of more efficient
mechanisms for controlling money supply.
Macroeconomic performances depend also on the design and goals of the
exchange rate mechanism. One may order exchange rate mechanisms in keeping with
the cost of changing the parity from the most to the least rigid: dollarisation or
euroisation ÷ currency board regimes ÷ credible peg (or fixed rate) ÷ non-credible
peg ÷ managed float ÷ fully flexible rates. The 1997 Asian crisis has much eroded
the confidence of policymakers in the developing world in the virtues of fixed rates
and other crawling pegs under the current international financial arrangements and
rules. It also put forward the increased scope for speculative lending and speculative
currency attacks in a world of increased capital mobility (Krugman, 2000). Not only
modern communication technology allows very rapid international transfers of funds
but also, in the context of a liberalisation Zeitgeist in the late 1980s and the early
1990s, both developed and many developing countries have removed all/most of
capital controls and restrictions in the last twenty years.
Whereas flexible managed rates is still the rule in practice, there is a rising
advocacy of super-fixed exchange rate mechanisms - against the background of rising
discontent with the working of the international financial system. Some economists
favour currency boards (Rivera-Batiz and Sy, 2000; Gulde, Kahkonen and Keller,
2000) and even dollarisation (Berg and Borensztein, 2000; LeBaron and McCulloch
2000). Gulde, Kahkonen and Keller (2000) argue that Eastern European countries