Exchange Rates in the New EU Accession Countries: What Have We Learned from the Forerunners?

IMF Working Papers, February 1, 2005

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Estimation and simulation of sustainable real exchange rates point to potential difficulties in sustaining the ERM2 regime if entered too soon and with weak policies.
According to the estimates, the Czech, Hungarian, and Polish currencies were overvalued in 2003.
Simulations, conditional on large-model macroeconomic projections, suggest that under current policies those currencies would be unlikely to stay within the ERM2 stability corridor during 2004-10.
In-sample simulations for Greece, Portugal, and Spain indicate both a much smaller misalignment of national currencies prior to ERM2, and a more stable path of real exchange rates over the medium term than can be expected for the new accession countries.

Estimation and simulation of sustainable real exchange rates in some of the new EU accession countries.
Comparative in-sample simulations using Greece, Portugal, and Spain as forerunner benchmarks.
Simulations are conditional on large-model macroeconomic projections.

Entering ERM2 too soon and with weak policies can create difficulties in sustaining the regime.
For the Czech Republic, Hungary, and Poland: the combination of estimated overvaluation in 2003 and simulation results implies a risk of exiting or breaching the ERM2 stability corridor during 2004-10 under prevailing policy settings.
The experience of Greece, Portugal, and Spain suggests that smaller pre-ERM2 misalignments and more stable medium-term real exchange rate paths facilitate a smoother ERM2 experience.

Subject: Currencies, Exchange rates, External debt, Foreign direct investment, Real exchange rates
Keywords: capital stock, exchange rate, nominal exchange rate, WP

IMF Working Paper by Katerina Smídková, February 1, 2005.