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Mr. Johannes Wiegand
When the euro was introduced in 1998, one objective was to create an alternative global reserve currency that would grant benefits to euro area countries similar to the U.S. dollar’s “exorbitant privliege”: i.e., a boost to the perceived quality of euro denominated assets that would increase demand for such assets and reduce euro area members’ funding costs. This paper uses risk perceptions as revelaed in investor surveys to extract a measure of privilege asscociated with euro membership, and traces its evolution over time. It finds that in the 2000s, euro area assets benefited indeed from a significant perceptions premium. While this premium disappeared in the wake of the euro crisis, it has recently returned, although at a reduced size. The paper also produces time-varying estimates of the weights that investors place on macro-economic fundmentals in their assessments of country risk. It finds that the weights of public debt, the current account and real growth increased considerably during the euro crisis, and that these shifts have remained in place even after the immediate financial stress subsided.
Nazim Belhocine, Ernesto Crivelli, Ms. Nan Geng, Tiberiu Scutaru, Mr. Johannes Wiegand, and Zaijin Zhan
The demands on monetary and exchange rate regimes in CESEE have evolved, in line with the region’s development. In the 1990s, the immediate challenge was to rein in excessive inflation following transition, and to establish basic monetary order. These objectives have been achieved, owing largely to successful exchange rate–based stabilization. With this accomplished, the focus has shifted to cyclical monetary management, and to appropriately managing monetary conditions during CESEE’s growth and income convergence to the euro area. Flexible exchange rates—and the ensuing capacity of monetary conditions to adapt to the economies’ needs—are likely to remain advantages, especially to extent that CESEE’s GDP and income levels will resume convergence to the euro area. Once this process restarts, tighter monetary conditions will again be needed to limit goods and asset price inflation, and to contain growth imbalances.
Mr. Atish R. Ghosh, Miss Mahvash S Qureshi, and Mr. Charalambos G Tsangarides
Milton Friedman argued that flexible exchange rates would facilitate external adjustment. Recent studies find surprisingly little robust evidence that they do. We argue that this is because they use composite (or aggregate) exchange rate regime classifications, which often mask very heterogeneous bilateral relationships between countries. Constructing a novel dataset of bilateral exchange rate regimes that differentiates by the degree of exchange rate flexibility, as well as by direct and indirect exchange rate relationships, for 181 countries over 1980–2011, we find a significant and empirically robust relationship between exchange rate flexibility and the speed of external adjustment. Our results are supported by several “natural experiments” of exogenous changes in bilateral exchange rate regimes.
International Monetary Fund
This 2009 Article IV Consultation highlights that the Lithuanian economy is undergoing a severe adjustment, after years of rapid economic growth and financial integration. With the global financial crisis, the unwinding of the imbalances accumulated during the boom has led to a sharp economic contraction. Capital inflows came to a halt in late 2008 and reversed in 2009, and the current account deficit turned into a surplus. Executive Directors have recognized the authorities’ strong commitment to maintain the currency board arrangement, which has served as a useful macroeconomic anchor.
International Monetary Fund
This paper uses VAR models to examine the magnitude and sources of growth spillovers to the Baltics from key trading partners, as well asfrom the real effective exchange rate (REER). Our results show there are significant cross-country spillovers to the Baltics with those from the EU outweighing spillovers from Russia. Shocks to the REER generally depress growth in the Baltics, and this intensifies over time. We also find that financial and trade channels dominate the transmission of spillovers to the region which partly explains the realization of downside risks to the Baltics from the global slowdown.
International Monetary Fund
With global financial turmoil increasingly spilling over into Serbia, the authorities have requested a 15-month Stand-By Arrangement (SBA), which they intend to treat as precautionary. The authorities’ program aims at safeguarding macroeconomic and financial stability, in view of the global financial turmoil. The authorities’ SBA-supported program responds to the abrupt deterioration in global financial sentiments. Safeguarding macroeconomic and financial stability are the primary objectives of the program, and the authorities recognize that policies will need to be strengthened across the board.
Mr. Christoph B. Rosenberg and Marcel Tirpák
The paper investigates the determinants of foreign currency borrowing by the private sector in the new member states of the European Union. We find that striking differences in patterns of foreign currency borrowing between countries are explained by the loan-to-deposit ratios, openness, and the interest rate differential. Joining the EU appears to have played an important role, by providing direct access to foreign funding, offering hedging opportunities through greater openness, lending credibility to exchange rate regimes, and raising expectations of imminent euro adoption. The empirical evidence suggests that regulatory policies to slow foreign currency borrowing have had only limited success.
International Monetary Fund
This paper estimated the output gap in Lithuania using three different methodologies—an HP filter, a panel regression, and a production function. This study examines how the levels of the current account deficit and the real exchange rate in Lithuania compare with estimates of their equilibrium values. The regression-based estimates are sensitive to the regression specifications and samples that determine equilibrium values. The large current account deficit in Lithuania may well be the equilibrium outcome of rapid income catch-up driven by strong fundamentals, including EU accession.
International Monetary Fund
In this report, economic performance of Lithuania over the past decade is discussed. These reflect on EU accession, rapid financial integration, and generally sound macroeconomic policies. Concerns about the rise in external and internal imbalances, characterized by an unsustainable current account deficit, and an increase in domestic inflationary prices, resulting from excess domestic demand are outlined. The findings of the Financial Assessment Stability Program (FASP) are welcome. The Bank of Lithuania’s measures in recent years to strengthen banks’ capital bases and encourage strong risk management are encouraged.