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Thesis submitted for assessment with a view to obtaining the degree o f
Doctor o f Economics o f the European University Institute
Florence
April 2007
3 0001 0048 3305 1
EUROPEAN UNIVERSITY INSTITUTE
Department of Economics
Essays in Empirical M acroeconomics
Thesis submitted for assessment with a view to obtaining the degree of
Doctor of Economics of the European University Institute
Jury Members:
Prof. Mike Artis, University o f Manchester, Supervisor
Prof. Anindya Banerjee, EUI
Prof. LioneI Fontagné, Université Paris I Panthéon-Sorbonne
Prof. Massimiliano Marcellino, Università Bocconi
© 2007, Tomasz Kozluk
No part o f this thesis may be copied, reproduced or
transmitted without prior permission of the author
Tomasz Kozluk
L I B
Essays in Empirical Macroeconomics
Ph.D. Thesis
Tom asz Kozluk
D epartm en t of E con om ics
European U niversity In stitu te
A pril 2007
A cknowlcdgemcnts
It is a pleasure for me to thank the many people who's support and help made this
thesis possible.
First o f all, I would like to warmly thank m y supervisors - Professors Mike A rtis
and Anindya Danerjee. It is hard to overstate the invaluable guidance, constructive
comments and continuous advice they offered both when I was fu ll o f enthusiasm but
also in the m ore difficult m om ents when I needed their support most. They were both
available and found the m il and tim e to listen to and comment on my proposals,
provide different views, suggestions and stimulate new research ideas. I therefore feel
highly indebted to them.
Next, I would like to thank Tirrio Valila from the E lB , two anonymous referees,
and participants at sevcml conferences all of whom provided valuable comments and
stimulating discussions during earlier stages o f my research. Moreover, I thank my
undergraduate professor Jim Walsh and his wife Christine fo r their advice and coach
ing.
I am also grateful to the secretaries at the European University Institute, especially
Jessica, who helped me out on a number of matters, were always enthusiastic even
when I bothered them with the m ost annoying issues. In fact, I am thankful to the
European University Institute, fo r providing an inspiring research atmosphere, as
looking back, m y time here was not only pleasant, but allowed m e to learn a great
deal and gain unforgettable experience. I owe special gratitude to the Polish grant
authority, and the Robert Schuman Centre fo r financing my stay here. A n d to the
EIB, E C B and a number o f Florentine restaurants fo r their hospitality.
Very im portantly I also owe an immense gratitude to a number o f my fellow re
searchers, who provided support both academically and personally. Starting from m y
flatm ates (in alphabetical order): Andrea, Chris, Dejan, Ilaria. Lidia and Stefan,
continuing with m y office-mates: Clara, Elvim and Irina and with m any others, with
whom adm ittedly I did not share a fla t or working space (yet): Matthcos, Pedro and
Zeno. Needless to mention the all-mighty gym group and m y team fro m Canottieri di
Firenze, which made my contact with Florence and Italian culture more direct (though
also more exhausting). N ot to forget, I thank m y very goal friends in Warsaw.
Finally a very, very special thanks fo r their love and care goes to my fam ily: m y
parents, m y brother and other loved ones. A nd above all to Magda, m thout whom I
would have no t been able to arrive at this stage.
Tomasz Kozluk, Florence, S(fh November, 2006
Ai — .— — i i - j - . A
Contents
Introduction
11
R e f e r e n c e s ... 17
Chapter I C E E Accession Countries and the EM U
19
1.1 In t r o d u c t io n ... 201.2 T h e O p tim u m C u rren cy A r e a ... 22
1.3 A ccessio n C o u n tries and th e E u r o z o n e ... 25
1.3.1 T h e M a astrich t T re a ty C r i t e r i a ... 20 1 .1 T h e D a t a ... 28 1.4.1 R ea l C onvergence V a r i a b l e s ... 28 1.1.2 N om inal C on vergen ce V a r ia b le s ... 30 1.5 T h e M e th o d o lo g y ... 31 1.5.1 Fuzzy C lu sterin g A l g o r i t h m ... 31 1.5.2 P rin cip al C om p on en t A n a l y s i s ... 33 1.0 R esu lts and D is c u s s io n ... 3 0 1.0 . 1 O C A C r i t e r i a ... 30 1.0. 2 M a a strich t C r i t e r i a ... 40 1.0. 3 R e su lts C o m p a r e d ... 57 I. 7 C o n c lu s io n s ... 59 R e f e r e n c e s ... 02 A p p en d ix A ... 04 A p p en d ix B ... 05
Chapter II How Easily is Public Investment Cut?
66
II. 1 I n t r o d u c t io n ... 0711.2 E x p la in in g P u b lic In v estm en t C h a n g e s ... 08
11.2.1 P u b lic investm ent in O E C D c o u n t r i e s ... 0 8 11.2.2 H y p o t h e s e s ... 72
3
--- j— »— i n i n - f m n n ii
---. ---
---MM
I I . 2 .3 E m p irica l w ork o n p u b lic in v e s t m e n t ... 7 5 II - 3 D a t a and m odel s e t u p ... « 0 11.3.1 T h e ec o n o m e tric m o d el ... 8 0 11.3 .2 V ariables ... 81 11.3 .3 E s tim a tio n t e c h n i q u e s ... 8 4 11.4 R e s u l t s ... 8G 11.4 .1 D is c u s s io n ... 88 11.5 C o n c l u s i o n s ... 93 R e f e r e n c e s ... 94 A p p en d ix A ... 9 7 A p p en d ix B ... 99 A p p en d ix C ... 10 0 C h a p t e r I I I M e a s u r i n g L o n g R u n E x c h a n g e R a t e P a s s - T h r o u g h 1 0 2 I I I . 1 I n t r o d u c t io n ... 103 111.2 E x c h a n g e R a te P a s s -T h r o u g h in to Im port. P r i c e s ... 10 0 111.3 E R P T - e s t i m a t i o n ... 1 1 2 111.4 D a t a ... 1 1 4 111.5 R e s u l t s ... 1 1 9 111.5.1 Sin gle e q u a tio n s - w ith o u t b reak s (im p o rta n c e o f lag len g th se le c tio n ) 119 111.5 .2 Single e q u a tio n s, w ith s tru c tu ra l b r e a k s ... 120 II I.f i P a n e l co in te g ra tio n t e s t s ... 130 I I I . 7 D iscu ssio n and co n c lu d in g r e m a r k s ... M 0 R e f e r e n c e s ... 15 5 A p p e n d ix A ... 1 5 7 A p p e n d ix B ... 158 A p p en d ix C ... 10 0 C h a p t e r I V E x c h a n g e R a t e P a s s - T h r o u g h in t h e N e w M e m b e r S t a t e s 1 7 2 IV . 1 I nt rod uct i o n ... 1 7 3
175
IV .2 .1 L ong run E R P T ... 178
IV .2 .2 E R P T in th e sh o rt r u n ... 180
IV .3 E m p irica l l i t e r a t u r e ... 180
IV .4 D a t a ... 182
IV .4 .1 E x c h a n g e r a te regim es and m o n etary p o l i c y ... 185
IV .4 .2 E x ch a n g e r a te regim es in C E E C s ... 187 I V .4.3 C E E C s - tra d e p a t t e r n s ... 194 I V .4.4 C E E C s and th e E u r o ... 194 IV .5 E s tim a tio n M e t h o d s ... 197 IV .fi R e s u lt s ... 20 2 IV .7 D is c u s s i o n ... 20G IV .8 C o n c lu s io n s ... 210 R e f e r e n c e s ... 211 A p p en d ix A ... 213 A p p en d ix B ... 214
• i i n i T i i i f m n J i r i i i H í i í M i r i f r — -
n a
List of Figures
C h a p te r I
1 K M C can d id ato s - S u ita b ility In d ex - 11 years b e fo re E M U ... 4 3 2 O C A - clu sters anti P C s co m p ared - 1 1 y ears b e fo re E M U ... 4 3 3 E M U ca n d id a te s - S u ita b ility In d ex - 5 y ears b e fo re E M U ... 4 4
4 O C A - clu sters and P C s co m p ared - 5 y ears b efo re E M U ... 4 5
5 E M U ca n d id a tes - H ead iness In d ex - 11 y ears b efo re E M U ... 51
G M C - clu ste rs and P C s c o m p a m l - 11 y ears b efo re E M U ... 5 5 7 E M U ca n d id a tes - H endiness In d ex - >5 y ears b e fo re E M U ... 5 5 8 M C - clu ste rs and P C s co m pa ret I - 5 y ears b efo re E M U ... 5G C h a p te r II 1 G o v ern m en t Investm ent a s
%
o f G D P ... 7 0 2 G o v ern m e n t Investm ent, a s%
o f T o ta l G overnm ent. D i s b u r s e m e n t s ... 7 1 3 R e s u lts - ro b u stn ess a cro ss d ifferent d efin itio n s v a r i a b l e s ... 0 14
D is trib u tio n o f fiscal co n so lid a tio n s acco rd in g to different, d efin itio ns . . . . 0 2 C h a p te r I I I 1 R e sid u a ls from E R P T reg ressio n - w ith an d w ith o u t b r e a k ... 1172 E x c h a n g e rates; eu ro area cu rre n cies versus th e U S D ... 110
3 L o n g run E R P T e stim a te s w ith con fid en ce in terv a ls - F ra net! ... 131
I L o n g ru n E R P T e s tim a te s w ith co n fid en ce in terv a ls - G e r m a n y ... 132
5 L o n g ru n E R P T e s tim a te s w ith con fid en ce in terv als - I t a l y ... 133
G L o n g ru n E R P T e s tim a te s w ith co n fid en ce in terv a ls - P o r t u g a l ... 134
7 D is trib u tio n of estim a ted b re a k d a t e s ... 1 3 7 8 D is trib u tio n of test s ta tis tic s ; fa c to r cro ss-se ctio n d e p e n d e n c e ... 145
Í) E x c h a n g e rates: E U R (E C U )/ U S D and E U R ( E C U ) / G I 1 P ... 153
10 D is trib u tio n o f estim a ted b re a k d a te s (C M s a m p l e ) ... 104 I I D is tr ib u tio n o f te s t s ta tis tic s : fa c to r cro ss-se ctio n d ep en d en ce (C M ) . . . . 1G5 C h a p te r IV
G
1 W eekly C Z K
exchange rate against
E C U / E U Rand
U S D ... 18G 2 W eekly E E K ex ch an g e r a te a g a in st E C U / E U R an d U S D ... 187 3 W eekly H U F ex ch an g e ra te a g a in st E C U / E U R an d U S D ... 188 4 W eekly L A T exch an ge ra te a g a in st E C U / E U R an d U S D ... 189 5 W eekly L T L ex ch an g e ra te a g a in st E C U / E U R and U S D ... 189 6 W eekly P L N ex ch an g e ra te a g a in st E C U / E U R an d U S D ... 190 7 W eekly S K K ex ch an g e ra te a g a in st E C U / E U R an d U S D ... 1918
W eekly S I Texchange rate against
E C U / E U Rand
U S D ...191
D S h a re o f E x tr a -E U 2 5 im p o rts in th e value o f to ta l im p o rts by in d u stry ( I) . 195 10 S h a re o f E x tr a -E U 2 5 im p o rts in th e value o f to ta l im p o rts by in d u stry ( I I ) 190 1 1 R ecu rsiv e estim atio n s o f sh o rt-ru n E R P T in to IU V s ( I) ... 208
12 R ecu rsiv e estim a tio n s o f sh o rt-ru n E R P T in to IU V s ( I I ) ... 209
Maouau M>l* r < I * * * { , *
List of Tables
Chapter I
1
Fiizzv Clustering results - Optimum Currency Area c r i t e r i a ...
37
2
Hard cluster characteristics, OCA criteria,
11
years before EMU ...
3
^
3
Hard cluster characteristics, OCA criteria, 5 years before E M U ...
39
I
OCA principal components characteristics . ...
41
5
Suitability I n d e x ...
42
G
Fuzzy Clustering results - nominal convergence...
47
7
Hard cluster characteristics, MC criteria,
11
years before E M U ...
IS
8
Hard cluster characteristics, MC criteria,
8
years before E M U ...
10
i)
Hard cluster characteristics, MC criteria, 5 years before E M U ...
50
10 MC principal component c h a ra c te ristic s...
r>i
II
Readiness Index...
52
12
Suitability Index compared ...
00
13
PC Analysis - detailed r e s u lts ...
05
Chapter II
1
Determinants of public investment - Literature sum m ary...
78
2
Estimation results - example sp ecificatio n ...
87
3
Public investment cuts during fiscal consolidation...
DO
•1
Panel unit root test results ...
OS
5
Changes in total disbursements indicated by fiscal cut dum m ies...
98
G
Results for different specifications...
99
Chapter III
1
Short and long run ERPT - example based on CM d e fin itio n ... 113
2
Share of extra-Eurozone imports in total im p o r ts ... 118
3
ADF tests on errors from long run re g re ss io n ... 121
4
ADE tests on residuals from long run regression ( I I ) ... 122
5 L ong ru n E R P T e s tim a te s - sin g le e q u a tio n s, no b re a k and b re a k in c o n sta n t 123
6
Long run ERPT estimates - single equations, break in constant and slope . 125
7
Panel cointegration test results - breaks, no cross-section dependence . . . .
13G
8
Long run ERPT estimates - no breaks and breaks in c o n s ta n ts ... 138
9
Long run ERPT estimates - break in slope...
141
10
Panel cointegration test results - breaks and factor cross-section dependence 145
11
ADF tests on residuals from long run regression (CM sam p le)... 158
12
Long run ERPT estimates - no break and break in constant (CM sample)
. 159
13
Long run ERPT estimates - break in constant and slope (CM sample) . . .
161
14
Panel cointegration test statistics - no cross-section dependence (CM) . . .
164
15
Panel cointegration test statistics - factor cross-section dependence (CM)
.
1G5
Chapter IV
1
Annual CPI inflation in C E E C s ...
192
2
Long run ERPT estimates for individual countries and sectors... 199
3
ADF tests on residuals from "estimated*’ long run ... 200
4
ADF tests on residuals from ’'imposed” long r u n ...
201
5
Test statistics for panel cointegration t e s t ... 202
6
Short run ERPT estimates (disaggregated) ... 203
7
Long run ERPT into aggregate IUV and CPI . ... 214
8
ADF tests on residuals from long run ERPT into IUV and CPI ( I ) ... 215
9
ADF tests on residuals from long run ERPT into IUV and CPI (II) . . . . 21G
10
Estimates of short run ERPT into total IUV and C P I ... 217
9
mnfiftfìhmtmiitoaAi
Introduction
On the I s* of January 1999 eleven European Union (EU) members fixed th eir cur
rencies to form th e Economic and M onetary Union (EMU). In the run-up to the
formation of th e euro area candidate countries had to fulfil a set of entry criteria
laid down in th e Treaty of M aastricht. These consisted of limitations on nominal
exchange rate volatility, and on th e levels of inflation, interest rate, public d ebt and
fiscal deficit. A fter th e successful formation of th e common currency, the countries
gave up individual m onetary policy to the European Central Bank (ECB), which
supposedly, at least for some, m eant a gain in credibility and a substantial change
in m onetary policy in general. Finally, following the latest wave of EU enlargem ent,
which took place on th e 1st of May 2004, in the next years we can expect new mem
bers to be aiming to join the euro. The five nominal criteria will most certainly
be applied to future enlargements. W hilst before EU entry practically all candidate
countries declared a willingness to join the euro ” as soon as possible” the question
wlicther they are ready and suitable to do so, is im portant.
Moreover, m any researchers, such as Gali and Perotti (2003) have expressed fear
that the fiscal entry criteria and the Stability and Growth Pact, which did not account
for cyclical conditions would cause a decrease in the level of public investm ent, as it
is often claimed th a t capital spending is less visible, and thus easier to cut than
current spending. If so, the restraints imposed by the Treaty and the Pact could
lead to an under-provision of infrastructure investm ent. If this argument were to be
supported by empirical evidence the preoccupation with the current inferior levels of
public investment could prove to be even stronger in the New Member States. There,
the current low levels of public infrastructure arc* regarded as a lim itation to growth
prospects while on the other hand in many, especially the larger New Member States
fiscal deficits tend to be above or close to the
of GDP maximum required to
join the euro area. Thus joining th e EMU will require fiscal consolidation, and there
11
trtnyrfrt—*-*-*-'
is a fear th a t, for the political reasons mentioned above. the cut will fall on public
investm ent spending and thus have an adverse influence on growth prospects.
Next, there are m any reasons to suspect that th e introduction of th e common
currency in Europe constituted a m ajor economic change. Tying together 11 and la te r
12 currencies, replacing them w ith one common currency, and giving lip m onetary
policy to the European C entral Bank gives strong reasons to suspect a stru c tu ra l
change in m onetary policy, and in the behavior of bo th the exchange ra te s against
th ird currencies and prices. Related to this, a good understanding of the link between
exchange rates and prices via tlie exchange rate pass-through, both in the current euro
members and in the New Member States is an im portant factor for m onetary policy
design and may be a relevant issue once the latter countries attem pt to adopt th e
euro.
This thesis consists of four chapters concerning th e empirical assessment of in ter
national macroeconomic issues related to the introduction of the European common
currency.
The first chapter of th e thesis analyzes the potential readiness of the New Member
States to join the euro area. It looks at nominal and real convergence indicators,
relative to the state of the same markers in the current EMU members in the 19t)0s.
T h e nominal criteria are a selected set of variables sim ilar to the M aastricht TVeaty
requirem ents, while the real criteria arc4 derived from th e Optimum C urrency Area
theory. As most of these criteria are regarded as endogenous, a direct com parison is
ra th e r undesirable, and an out-of-tim e approach is taken, th a t is th e C entral Eastern
European Countries (CEECs) are compared w ith the current EMU m em bers within
a sim ilar tim e of potential EMU entry.
The second chapter focuses on the effects of the political horizon, large fiscal
cuts and the run-up to the euro area on public expenditure. Here the effect of elec
is investigated. Additionally the chapter addresses th e question whether th e fiscal
restrictions related to the introduction of the euro had any effect.
C hapter III analyzes the long ru n exchange rate pass-through, proposing a new
working definition of the long run E R P T which is less a rb itra ry than the ones present
in the empirical literature, and is based on theoretical underpinnings. It th en looks
deeper into w hether individual industries in EMU m em bers can be found to have
full pass-through, whether this pass-through was affected by the introduction of the
common currency, and if so, in which way had this effect worked.
C hapter IV is intended as a link between C hapters I and III. It deals w ith the
estim ation of short run E R PT into im port prices in the Central and Eastern Euro
pean States. Moreover, it extensively reviews exchange ra te developments in these
countries, finding th a t the choice of the exchange rate regime does n o t seem to be a
m ajor determ inant of the degree to which nominal effective exchange ra te fluctuations
are passed on to the im port price level.
All C hapters are empirical, and use up-to-date econometric tools. In more detail,
the first C hapter ” CEE Accession Countries and th e EMU - An Assessment of Relative
Suitability and Readiness for Euro A rea Membership” asks the question w hether the
New Member States look ready to adopt the euro. Eastward enlargem ent of the
euro a rea will result in transition economies sharing a currency w ith well-established
market economies. There seem to be vast economic a n d institutional differences
between the New Member States an d the EMU participants. Therefore, in this paper,
I compare the suitability (in term s of the O ptim um Currency Area theory) of the
candidates relative to the current members at a similar tim e before joining, as well
as their readiness to comply w ith M aastricht criteria. Using fuzzy clustering and
principal components, we assess p attern s of convergence, possible inhomogeneities
within th e future 'enlarged* euro area and create readiness and suitability indexes.
We find the CEECs more suitable in terms of OCA criteria and more ready than
some of the (southern) current members once were. Moreover, they are not found to
follow distinct convergence paths. This analysis was carried out in 2002. and at th a t
point the assum ption th a t all CEECs may aim at an early entry date was plausible.
A lthough, as we know, due to various, quite often exogenous developm ents, m any
New Member States have postponed, or have been forced to postpone joining th e
euro, the main conclusions of th e paper still appear to hold. Of the countries th a t
have not decided to join in 2007 the CEEC-4 (Czech Republic, Hungary, Poland a n d
Slovakia) did so mainly because of the lack of political support for early m em bership,
connected somewhat with the unwillingness to reduce rather high fiscal deficits, th u s
in a sense because of the lack of th e drive to fulfil the criteria rath er than the technical
infeasibility. As for the other 4 New Member States from Central and Eastern Europe,
they seemed to aim at an early entry date; however in three cases these a tte m p ts were
invalidated by the inflation criterion. In the end Slovenia seems likely to he the only
country to join the EMU in 2007 however th e failure of the Baltic States to satisfy
th e inflation criterion seems ra th e r the fault of the (currently) exceptionally low value
of th e benchm ark, which was not the ease when the euro area was formed.
In the next chapter. ” How Easily is Public Investment Cut? A Dynamic Panel
Approach" using a dynamic panel of 19 OECD countries over 1971-2001 I analyze
the movement o f public investm ent spending. Controlling for downward trends in
m any countries, I focus on short-term movements and find investment a fairly rigid
albeit pro-cyclical component of government spending. This means that on average
public investm ent tends to fluctuate less th an current expenditures, however I also
find that in severe fiscal restrain ts it is public investm ent that is m ostly affected.
M om jver, th e fiscal consolidations related to the adoption of the euro do not seem
to differ in this respect. However, this cannot be treated as evidence that the fiscal
rules accompanying the intro d u ctio n of the euro had no effect at all. In a num ber of
public investm ent spending very significantly, could be observed during the run-up
to the EMU. T h a t is, the urge to fulfil the M aastricht Treaty criteria may have
contributed to th e reduction of public investment spending because of the need to
reduce fiscal deficit in total. As according to the findings of the previous chapter
one of the m ain obstacles for EMU membership of the CEECs will most probably
be the fiscal deficit criterion, fiscal consolidation can be expected to occur once these
countries make the attem p t to jo in the common currency. From this chapter, it
results th a t one may therefore expect large cuts of public investment spending which
may not be desirable in countries w ith low levels of infrastructure. Moreover, I find a
strong link between th e ’’policy horizon” of a governm ent and public investment, in
the sense th a t weaker, more myopic governments prefer to lay even more weight of a
fiscal consolidation on investm ent spending in order to preserve current spending.
The third chapter "M easuring Long Run Exchange R ate Pass-Through” is co
authored with Olivier de B an d t from the Bank of France and Anindya Banerjee from
the EUI. Here, we discuss th e issue of estim ating short- an d long-run exchange rate
pass-through (E R P T ) into im port prices in individual industries in the euro area
countries and ask the question w hether the introduction of the common currency
had an effect on the degree of long run pass-through. We show how the measures
of this rate proposed by recent p ap ers may be flawed. T he underlying theoretical
considerations suggest the existence of a long-run relationship in th e sense of Engle
and Granger (1987) between im port unit values, the exchange rate and a measure of
foreign prices. T his long-run relationship is typically ignored in the empirical analysis
and an ad hoc alternative definition of the long run pass-through is proposed. We
describe why th e Engle and G ranger (1987) long-run coefficient is im portant, how
it may be restored to the empirical analysis by taking account of varying lag length
and of stru ctu ral breaks, and most im portantly what difference is made to the policy
debate surrounding exchange ra te pass-through by differentiating between alternative 1
5
15
iiWKihwH
m easures o f this variable. O ur discussion is undertaken using; tim e series and p a n el
d a ta techniques for testing for cointegration in the possible presence of stru c tu ra l
breaks. T h e main findings are th a t in the long run E R P T is close to unity, especially
in com m odity sectors over all th e countries. Moreover, in the other sectors we a r e
able to reject the hypothesis o f zero pass-through in th e long run more often then in
previous papers. Next, even in the cases of the m anufacturing sectors where p ass
through equal to one is rejected, the point estim ates are generally higher than in
previous studies and closer to one. Finally we find th a t if we allow for the E R P T
to change on an estim ated break date, in most cases this change occurs close to tin*
introduction of the euro o r in th e vicinity to th e im portant turn-around in the euro
dollar developments. Wc find th a t long run E H PT generally increased, for which wo
provide possible explanations.
The final chapter focuses on th e estim ation of th e pass-through from th e nominal
effective exchange rate into im port prices in Central Eastern European countries.
Applying sim ilar methodology as in the previous chapter I arrive at th e conclusion
th a t E R P T was not prim arily driven by the choice of the exchange rate regime. In
a num ber of countries characterized by very different- exchange rate1 arrangem ents I
find full or close to full an d im m ediate pass-through into import price's in general an d
especially into commodity prices. Moreover, I find th at even in the short run a large
degree of th is effect seems to he passed on further to th e consumer prices, which may
potentially cause some overlooked vulnerability for th e countries w ithin th e ERM II.
W ithin th e chapters o f this thesis 1 use a wide range of empirical tools. In C h ap ter
I, following the work of A rtis and Zhang (2002) I use fuzzy clustering which allows
the search of partitions in a m ulti-dim ensional data set. This is a some what non
stan d ard technique and th e outcom e is rath er indicative than rigorous, and therefore
it is augm ented with th e extraction of principal components and the form ation o f
to as classical multi-dimensional scaling. In the next C h ap ter, I use stan d ard static
and dynamic panel methods, startin g from a pooled OLS estim ator, a Least Squares
Dummy Variable (LSDV) estim ator together with the Anderson and Hsiao (1981)
Instrum ental Variable estim ator and the Arellano and Bond (1991) GMM estim ator.
In a set of M onte Carlo simulations, I evaluate th e performance of th e different esti
mators within panels of similar dimensions and setup a n d conclude th a t th e LSDV
and AB-GMM estim ators seem the m ost appropriate for the purposes of the paper.
Finally, in C hapter III and to a more lim ited extent C hapter IV we apply an entire ar
ray of residual based measures in order to test for cointegration - st arting from simple
ADF tests with different lag selection criteria, then switching to Pedroni (1999) type
panel cointegration tests with no cross-sectional dependence and the Banerjee and
Carrion-i-Silvestre (200G) test with a common factor type dependence. Finally, these
are extended by methods th a t allow for structural breaks, be it in single equations,
as in Gregory and Hansen (199G), or in panels.
References
Anderson, T.W . and Hsiao, C. (1981), Estimation o f Dynamic Models unth Error
Com ponents
,
Journal of the American Statistical Association, Vol. 7G, pp. 598-
GUG.
Arellano, M. an d Bond. S.(1991), Sonic Tests o f Specification for Panel Data: M onte
Carlo Evidence and an Application to Em ploym ent Equations
,
The Review of
Economic Studies Vol. 58, pp. 277-297 .
Artis, M .J. and Zhang, \V.(2002), Membership o f EMU: A Fuzzy Clustering Analysis
o f Alternative Criteria, Journal of Economic Integration, Vol. 17, pp. 54-79.
Banerjee, A. and Carrion-i-Silvestre, J.(2006), Cointegration in Panel D ata with
Breaks and Cross-Section Dependence, ECB Working Paper no. 591.
Engle, R. and G ranger C .(1987). Co-integration and error correction: Representation,
estimation, and testing.
Econometrica, vol. 55. pp. 251-2TG.
Gali, J., Perotti, R.(2003), Fiscal Policy and M onetary Integration in Europe,
Eco
nomic Policy, vol. 18, pp. 533-572.
17
G r e g o r y . A . a n d H a n se n . 1 3 .(1 9 9 0 ),
R csu lu al-b a scd T ests f o r C o in teg ra tio n in M o d e ls
w ith R eg im e S h ifts.
J o u r n a l o f E c o n o m e t r ic s , v o l. 7 0 . pp. 9 0 - 1 2 0 .I V d r o n i.
1’.
( 1 9 9 9 ) .C r itic a l V alu es f o r C o in teg ra tio n T ests in H ete r o g e n o u s P a n e l s
w ith M ultiple R tg resso rs.
O x fo r d B u l le t i n o f E c o n o m ic s a n d S t a t i s t i c s , S p e c i a l is s u e ( 1 9 9 9 ) , p p . 0 0 :1 -0 7 0 .Chapter I
C EE Accession Countries and the EMU
an Assessment of Relative Suitability and
Readiness for Euro Area Membership
Abstract
E astw ard en larg em en t o f th e E u rozo n e w ill result in tra n sitio n eco n om ies sh arin g a cu rre n cy w ith w ell-estab lish ed m ark et eco n om ies. W e compart? th e su ita b ility (in term s o f O p tim u m C u rren cy A re a th e o ry ) o f th e ca n d id a tes re l a tiv e to cu rre n t m em bers a t a sim ilar tim e before jo in in g , as well as th e ir readiness to co m p ly w ith M a a strich t C rite ria . U sing fuzzy c lu s te r an aly sis and p rin cip al co m p o n en ts, we a sse ss p a tte rn s of convergence, po ssible in h o m ogeneities w ith in th e fu tu re E u ro z o n e and c r e a te readiness and su ita b ility indexes. W e find th e C E E C s m o re su ita b le in term s o f O C A c r ite ria and m o re ready th a n so m e o f th e cu rre n t m em b ers o n c e wore. M oreover, th e y are n o t found to follow d istin c t co n v e rg e n ce p ath s.*
J E L C lassificatio n N u m bers: F 3 3 , FO, F l o , CG
K eyw ords:
Econom ic and M onetary Union. Nominal Convergence. Heal Convergence,
Optimum CwTcncy Area, Central E astern Europe.
*A version of this paper has been published in the Journal of Economic Integration, Vol. 20,
September 2005, pp. 430-474. For a detailed, up-to-date overview of the developments on the issue
of Central and Eastern European New Member States and the EMU, we refer the reader to Section
4.4 in Chapter IV of this thesis.
19
l
i
I . l
In trod u ction
O n th e 1>/ o f M ay 2004 te n E u ro p e a n co u n tries jo in th e E u ro p ean U nion. T h e e n la rg e m e n t
ag reem en t d o es not allow for an y o p t-o u t clau se, as in th e ease o f th e U.I\. and D e n m a r k ,
th u s th o se co u n tries will lx? bo u n d to eventu ally en ter th e E co n o m ic and M o n e ta ry U n io n .
D u e to th e e n try requirem ents, th is should not happen ea rlie r th an 2 0 0 7 . A s th e re s e e m
to b e sig n ifica n t benefits o f jo in in g th e com m on E u ro p e a n cu rrency, it is o ften a rg u e d
th a t it w ould b e d esirab le for th e ca n d id a te co u n tries to adopt th e eu ro u n ila te ra lly ( s e e
for e x a m p le \ u ti, 2 002: C o rice lli, 2 0 0 2 ; B ratk o w ski an d K ostow ski, 2 0 0 2 ). T h is o p tio n ,
how ever, is stro n g ly d iscouraged by th e E U , an d th e refo re does not seem p lau sib le f o r
th e tim e b e in g . T h is m eans, th a t th e can d id a te co u n trie s will have to fulfil th e e n tr a n c e
c r ite r ia p osed by th e M a a strich t T re a ty . T h is lead s one to ask w hether th e se co u n tries a r o
re a d y to fulfil th e req u irem en ts? A re they, in g en era l, s u ita b le for co m m o n cu rre n c y a r e a
m e m b e rsh ip ? W ill this bo d o n e th ro u g h stead y co n v erg en ce, or b e a o n e -tim e effo rt, fo r
e x a m p le by red u cing th e fiscal d e fic it ex cep tio n a lly for o n e y ea r in stead o f m o re th o ro u g h
re fo rm , y ield in g perhaps p ro b lem s in com p ly ing w ith th e S ta b ility and G ro w th P a ct o r a n y
a rra n g e m e n t th at may rep lace it in th e future?
T h is p a p e r aim s to find o u t in w hat respect th e C e n tr a l E u rop ean accessio n c o u n trie s
fit th e p a tte r n s distinguished a m o n g cu rren t m em bers o f th e E M U . T h e e x e rcise se a rch e s
for s im ila ritie s am ong th e co n v e rg e n ce paths tow ard s co m m o n cu rren cy ad o p tio n o f t h e
cu rre n t E u ro z o n e sta te s and th a t o f c a n d id a te co u n tries. In ord er to shed so m e light o n
th e p e rfo rm a n c e o f th e a cc e ssio n s ta te s , th e a n a ly sis lo o k s at how th e y fit in th e c o r e
an d n o rth / so u th p eriphery p a r titio n found in previous w ork (see for e x a m p le A rtis an d
Z h an g . 2 0 0 1 ; A rtis and Z hang, 2 0 0 2 ) .
it will ta k e to fulfil th e e n try requ irem en ts, while th e O p tim u m C u rren cy A rea (O C A )
ch a ra c te ristic s serv e to ju d g e th e su ita b ility o f th e accessio n co u n tries re la tiv e to cu rre n t
m em bers. H isto rically , th e 8 C en tral E a s te rn E u rop ean ( C E E C s ) enlargem ent s t a te s are
form er co m m u n ist co u n tries w ith cent rally-p lanned eco n om ies. S ix o f th e m form ed p a rts
o f o th e r co u n tries, and in fa c t o f o th e r cu rren cy unions in th e early 1990s. T h is su g g ests
sign ifican t d ifferences from th e cu rren t m em bers.
If th e C E E C s ca n b e found to e x h ib it strong, p e rsisten t d issim ila ritie s in co m p a riso n
to E M U m em bers, th is m ay b e an in d ica tio n th a t th e y m ay b e sign ifican tly less s u ita b le
for E M U , or add t o th e in hom og eneity o f th e E u rozone. In th is case, e n tra n c e will h ave a
stro n g im p a ct o n th e co n d u ct o f m o n etary policy an d effects. W h ile finding th ey convorgw l
in a sim ila r way as cu rre n t m em bers did c a n help p red ict th e im p a ct o f a co m m o n c u rre n c y
by looking a t E u ro zo n e s ta te s and th e ir tro u b le s in co m p ly in g w ith th e S G P , th e ir p o te n tia l
gains and losses from jo in in g th e E M U . T h e idea o f th is sim p le exp erim en t is to ap p ly
fuzzy clu sterin g to look for p a rtitio n am o n g a set o f cu rrent E M U m em bers and accessio n
sta te s, a s possible e n tra n ts to th e eu ro a re a . T h e resu lts are co n fro n ted w ith th a t o f a n o th e r
m u ltiv ariate an a ly sis tool - p rin cip al co m p o n en ts, w hich serves for th e cre a tio n o f ’re a d in e ss1
and ’s u ita b ility ’ indexes for th e c a n d id a te co u n tries and re la tin g them to cu rren t E u ro z o n e
sta te s.
As b o th th e M a a stric h t C rite ria and O p tim u m C u rre n cy A re a c rite ria a re o ften argu ed
to b e end ogenous, co m p arin g co u n tries alread y in th e E M U w ith ca n d id a tes w ould b e
p ro b lem atic and in effect, u n d esirab le. In stead , th is p a p e r focuses on a n o u t-o f-tim e ’
an aly sis, th at is, it looks a t d a ta at a c e r ta in period o f tim e b efo re accessio n , a ssu m in g th e
earliest possible e n try d a te fo r th e C E E C s i.e. 2007, and com p ares ca n d id a te co u n trie s w ith
m em bers, w ithin
n
y ears b efo re entry. T h a t is, we perform co m p a ra tiv e s ta tic s lo o k in g at 2121
tI
k? year 2007 — n for CEECs, 2001 — n for Greece and 1900 - n for the* other EMU states.
T h is o u t o f tim e' an aly sis is c e rta in ly not flaw less, b u t has th e advantage* o f avoiding the*
ex ante
vs.ex post
p roblem . A m ong th e d raw b ack s, th e most seriou s is d efin itely t h e fact th a t ch an g es o f all th e o th e r ch a ra cte ristic s - th e so calk'd 'sta te -o f-th e -w o rld ' a r eignored . T h e se inclu d e various a s p e c ts , som ew hat e x te r n a l to o u r an a ly sis, as th e fact o f
E U m em b ersh ip , E R M p a rtic ip a tio n and g en erally s u b s ta n tia lly d ifferent m o n e ta ry re g im e s ,
levels o f E u ro p e a n in teg ratio n , s t a t e o f th e world eco n o m y and in teg ratio n and te c h n o lo g y
d ifferen ces betw een th e tw o d ecad es. Amid th e se re serv a tio n s, th e m eth o d o lo g y pursueM s t i l l
seem s to y ield a reaso n ab le tra d e -o ff, although co n clu sio n s must he draw n w ith re se rv a tio n .
As a resu lt o f o p era tio n a liz in g O C A theory, we te n d to find a co n c e n tric c o re / p e rip h e ry
s tru c tu re o f th e p o te n tia l co m m o n cu rren cy a re a , w ith th e C E E C s , b len d in g in to th is p a t
te rn . T h e tra n sitio n co u n tries co n v erg e well enou gh, so t h a t w ithin 5 y ears o f E M U m e m
b ersh ip , th e y becom e classified a s well d istrib u te d in th e core/periphery p a tte rn , w h e n ;
clo sen ess to G erm an y seem s to g o v ern su ita b ility . In te r m s o f nom inal co n v erg en ce, s o m e
C E E C s , n a m ely th e I ia lt ic s ta te s and th e C zech R e p u b lic e x h ib it h ig h er read in ess to fu lfil
th e M a a strich t crite ria th a n m o st cu rre n t m em b ers d id w ithin 5 y ears o f en try . In f a c t ,
alth o u g h o fte n s ta rtin g from a fa r aw ay p o sitio n , a c c o rd in g to th e m eth o d o lo g y used, n o n e
o f th e tra n sitio n co u n trie s are, w ith in 5 y ears o f p o te n tia l E u rozo n e m em b ersh ip , less re a d y
to q u alify th e n th e E M U o u tliers w ere at a sim ila r p o in t.
1.2
T h e Optimum C u rren cy A rea
T l ie O C A th e o ry was developed b y M undell (19G 1) and M cK in n o n (1 0 0 3 ) and acco rd in g to
th e p rim ary view , an o p tim a l c u rre n c y area is a fairly ho m o gen ou s region w ith sy n ch ro n ized
m ore recent overview o f th e th eo ry c a n b e found in T a v la s (1 9 9 3 ). T h e a u th o r m entio n s
th e follow ing c h a r a c te ris tic s o f o p tim a l p a rtic ip a n ts o f a co m m o n cu rre n cy zone:
• S y n ch ro n iz a tio n o f bu siness c y c le s and su pply/d em and shock s - sim ila r c y cle s, shocks
and re actio n s reduce th e need for sep a ra te m o n eta ry policies,
• S i m i l a r i t y o f in f la tio n r a t e s - O C A t h e o r y a t t r i b u t e s s i m i la r l e v e ls o f i n f la t io n t o
s i m i la r p r e f e r e n c e s o n i n f la tio n , t h u s a low c o s t o f j o i n i n g a c o m m o n c u r r e n c y ,
• F a c to r m o b ility - w hen high, is seen as a s u b s titu te fo r exch an ge ra te m o vem ents in
pro m o tin g ex te rn a l a d ju stm e n t,
• P ric e anti w age flexib ility - less rig id ity am ong o r betw een regions re su lts in a less likely
o cc u rre n ce o f th e sit uat ion w hen o n e region is tro u b led by high u nem p loy m en t and th e
o th e r by high inflat ion b ecau se o f th e lack o f scop e for real ex ch an g e ra te a d ju s tm e n t.
T h e re fo re , flexib ility serves a s a n a sy m m e tric sh o ck -ab so rb in g m ech an ism ,
• G o od s m ark et in teg ra tio n - co u n trie s w ith a sim ila r prod u ction s tr u c tu r e are less
prone to asy m m etric sh o ck s, an d th u s face lower c o s ts o f fixing th e ir cu rre n cie s to
each o th e r, and pursuing a co m m o n m o n etary policy,
• O p e n n e s s a n d e c o n o m y siz e - s m a l l , o p e n e c o n o m i e s t e n d t o p r e f e r fix e d e x c h a n g e
r a t e s , a s e x c h a n g e r a t e m o v e m e n t s h a w b ig g e r d i s r u p t i v e e l f e c t s t h a n in r e l a t i v e l y
c lo s e d e c o n o m ie s ,
• T ra d e in teg ra tio n - jo in in g a co m m o n cu rre n cy d isp o se s o f th e e x c h a n g e ra te risk
asso cia te d w ith tra ilin g , thu s is m ore favorable for co u n trie s w hich tra d e intensively
w ith each o th e r,
• Dogrcx» o f co m m o d ity d iv ersificatio n - highly diversified eco n om ics a r e less v u ln e r a b le ,
w hen hit by se c to r-sp e cific shocks.
• S m a ll need for real e x ch a n g e ra te v o la tility - h isto ric a lly low ex c h a n g e ra te v o la t il it y
su g g ests low cost o f fixin g th e cu rren cies,
• F is c a l in teg ratio n - a high level o f fiscal h a rm o n iz a tio n betw een co u n tries, would a llo w
fo r in ter-reg io n al tra n sfe rs th a t aim a t sm o o th in g out th e effects o f d iverse sh o ck s.
T h e th e o ry o f th e O p tim u m C u rre n cy A rea h as been h ighly criticized as th e sh eer fa ct o f
jo in in g a co m m o n cu rre n cy a r e a is asso ciate d w ith a m a jo r change in th e eco n om y o f a
co u n try . T h e r e have l>een m an y a tte m p ts to o p e ra tio n a liz e O C A th e o ry (se e for e x a m p le
B ayo u rn i an d F ich e n g re en , 199b and referen ces th e re in ), but p ractically all a re tr o u b le d
by th e p ro b lem o f th e en d o g en eity o f th e c r ite r ia th em selv es. T h is was sh a rp ly posed b y
F ra n k e l an d R o se (1 9 9 7 ) and F ran k e l and R o se ( 1 9 9 8 ). B y looking a t e x -a n te in d ic a to r s ,
o n e ca n n o t d raw d efin ite co n clu sio n s on th e o p tim a lity o f a cu rren cy union. A c a n d id a te
seem in g u n fit for a m o n etary u nion w hen lo o k in g a t h isto rical O C A in d ica to rs m ay w e ll
tu rn out a n o p tim al m em b er o n ce in, as th e so le fact o f jo in in g a com m on cu rre n cy c h a n g e s
th e n a tu re o f th e O C A v a ria b le s. In fa c t, a m o n e ta ry union will m ost p ro b ab ly foster a n
in crea se in tr a d e in teg ra tio n . B u sin e ss cy cle c o rre la tio n c a n change as a co n seq u en ce o f t h i s ,
th o u g h th e th e o ry is not co n siste n t a b o u t th e d ire ctio n o f th e change. M ore in te g ra tio n ,
th ro u g h In tra -In d u s try T ra d e m ay fo ster co n v erg en ce and sy n ch ro n izatio n o f tlie cy cles, b u t
on th e o th e r hand m ay lead to sp e cia liz a tio n (see for e x a m p le K ru g m an and V en ab les, 1 9 9 3 )
an d th e re b y m ore a sy m m etric sh o ck s. A lth o u g h th e th e o re tic a l pred ictions a re am b ig u o u s,
F ran k el an ti R ost; (1 9 9 7 ) c la im to find stro n g su p p o rt for th e first scen ario in th e ir e m p iric a l
As for th e in flatio n ra te sim ila rity c r ite ria , it is im p o rta n t to notice th a t O C A th eo ry
was m ain ly developed under th e b e lie f o f th e inflation -u n em p loy m en t t r a d e o f f ( th e P h ilip s
cu rve). T a k in g th e later recognized , v ertical long-run P h ilip s curve, su gg ests t h a t th e in
flatio n in a co u n try m ay no t b e a c tu a lly th e result o f in fla tio n preference, but p e rh ap s o f
th e cre d ib ility o f th e policy m akers. Supposedly, en terin g a m o n etary union should im prove
cred ib ility , th u s m ake easier th e m a in te n a n c e of lower in flatio n .
E v en la b o r m o bility ca n b e su sp ecte d o f being end ogenous. B e rto la (1 9 8 9 ) a s cite d in
T av las (1 9 9 3 ) proposes a m odel in w hich fixing th e ex ch an g e ra te reduces th e in co m e risk
betw i'en th e regions, and th u s fo sters m ore interregional m obility. F iscal in te g ra tio n may
in fact w orsen th e response to co u n try sp ecific shock s, as th e local policies m ay b e b e tte r
fine-tuned to d eal w ith th em .
S u m m arizin g , th e su sp ected en d o g en eity o f th e O C A c r ite ria poses a th r e a t to th e
cre d ib ility o f e x -a n te an aly sis, th o u g h in fact h isto rical in d ica to rs are so m etim e s th e only
to o ls av ailab le. T h is is a c tu a lly an arg u m en t in favor o f u sing sim ilarity and co n v erg en ce to
m em ber co u n tries a t th e sim ila r sta g e prior to en try in o rd er to shod som e light o n p o ssible
o u tco m es for th e ca n d id a tes.
1.3
A ccession C ountries and the Eurozone
A fter th e accessio n to th e E U , th e C e n tra l E u rop ean co u n trie s will b e req u ired , by th e
T re a ty o f M a a s tric h t, to jo in th e E M U ’as soon as they will b e ready’ . O ne o f th e most
stressed a d v an tag es would b e th e c r e d ib ility gain, since th e full ad op tion o f th e eu ro , de
sp ite h isto ric a l cases o f cu rre n cy u n io n s ’ breakdow ns, seem s a very stron g and tru stw o rth y
co m m itm e n t. T h e loss o f th e e x c h a n g e ra te as an a d ju stm e n t m echanism fo r a b so rb in g
asy m m etric sh o ck s does not seem a p rim a ry co n cern , as it is not ce rta in w h eth er it serves
B
7 1 1 1 1
^ J- -g
*-*-■ - ^ =- *- r , h i
th is purpose? or co n tra rily is a source? o f d istu rb a n ces itse lf (th e re is som e e v id en ce for t h i s
fro n t th e cu rrent EU m em b ers, see for in sta n ce A rtis and E h rm a n n , 2 0 0 0 ). Therefore?, it
c a n b e e x p ic te d th a t C E E C s will not only b e obliged to , but also a im for e n te rin g the? E M U
a s so o n a s possible (fo r an overview of arg u m en ts in favor o f eu r o t a t io n , see? for ex am p i e
N u ti, 2 0 0 2 ; C oricolli, 2 0 0 2 ; B ratk o w sk i and Ito sto w sk i, 2 0 0 2 ). T h e e n try co n d itio n s d i s
c u s s a l below include E U m em bersh ip anel requ ire a tw o y ear e x a m in a tio n p erio d . T h u s ,
2 0 0 7 is p ro b ab ly th e e a rliest p lau sib le d a te for E u ro z o n e accession, and will be? th e e le fa u lt.
d a te in th e analy sis co n d u ct eel.1
1.3.1 The Maastricht Treaty Criteria
The? M a a strich t TV<;aty o f 1002 definexl nom inal p rereq u isites o f th e ex-onomy, m?ce?ssary f o r
E M U m e m b ersh ip . A m ong th e req u irem en ts to be? fulfille'd by ca n d id a tes a re ;
* for twe> years p rior to e n try elate:
- the nom inal e x c h a n g e r a te rem ain ing w ith in th e ± 159e E R M II bonne Is, w ith o u t
devaluation o f th e ce?ntral ra te ,
• for one? year prior to en try elate:
- the? inflation r a te no more? th a n 1
.Wi
p o in ts ab o v e th e average o f th e three; E U m em bers w ith lowe;st in fla tio n ,- the; inte?re?st r a t e on lo n g -term governm ent b o n d s ne> m ore th a n
'
1%
p o in ts a b o v e the; average o f th e th re e lo w -in flatio n eem ntrios.- Imelget eleficit not ex ceed in g 3 (/i e)f G D P ,
U'his date* was the officially declared target date for Lithuania, Estonia and Slovenia. Due mainly
to inflation developments the two Baltic States were eventually forced to postpone this date. l or
more details on this issue and an overview of the developments in the strategies to join the euro wt>
refer the reader to Section 4.4 in Chapter IV of this thesis.
- government debt no higher than 00% of GDP,
At least tw o issues are w orth n o tin g : first o f a ll, th e la st tw o o f th e so called ’M a a strich t
C rite ria ( M C ) ’ have been applied som ew hat less s tr ic tly to cu rre n t E M U m em b ers, as th e y
are acc om p an ied by a cla u se w hich allow s for higher values if converging o r on an ex c e p tio n a l
basis. Seco n d , th e inflation and in terest ra te c rite ria are assessed re lativ e to E U , not E M U
m em bers, and th u s may, in fa ct be ju d g ed relative to o th e r a p p lica n t co u n tries, o r even th e
o p t-o u t co u n tries.
T h e above c rite ria have been w id ely criticized (see for in stan ce Ilu ite r, C o rs e tti and
R o u b in i, 1!)93; B ratk o w sk i and R o sto w sk i, 2 0 0 2 ), m ainly for th e a rb itra rin e ss o f th e values
and for acco u n tin g only for th e n o m in al side o f co n v erg en ce and s ta b ility , w hile ignoring
th e real side. T h e y do not accou nt for any cy clical a d ju stm e n ts, do not d istin g u ish betw een
various types o f pu blic sp end ing, art; to a large degree end ogenous and ta k e in to e x a m in a t ion
a very short p erio d . T h e assessm ent o f th e ap p ro p riaten ess o f t he crite ria is beyond th e scop e
of th is paper, but as most p ro b ab ly form ing th e o b lig a to ry b en ch m ark , th e y w ill b e used
below for t he ev alu at ion o f t he read in ess o f accession co u n tries for E u ro zo n e m em b ersh ip .
As m entio n ed , th e A ccession C o u n trie s upon jo in in g th e E U will b e bound to e n te r th e
E M U , a s soon a s th ey fulfil th e M a a strich t C rite ria , as no o p t-o u t clau se has b een allow ed.2
In th is paper, we tak e a look at th e p erfo rm an ce o f th e eig h t C E E c a n d id a te co u n tries,
acco rd in g to th e M aast richt req u irem e n ts, and co m p are th e ir situ atio n to th e one o f cu rren t
E M I ’ s ta te s w ith in a sim ilar am ount o f y ears befo re en terin g th e co m m o n cu rren cy .
2Admitted]}-, there1 is
littlepressure to do so, and as can be seen from the example of Sweden,
which is the only 'old’
EUmember without an opt-out clause and outside
the EM U- the decision
to join can in practice be postponed.
27
1.4
The D ata
T h e E M U can d id ate C E E C s have undergone tr a n s itio n from re n t rally -p lan n ed t o w a r d s
m ark et (economies. T h is p ro cess is a ctu a lly still co n tin u in g , but undoubt w ily th e r e h a s
been a m a jo r stru ctu ra l break in th e end o f th e 1 9 8 0 s and th e b eg in n in g o f th e 1 9 9 0 s i n
th e c h a r a c te ris tic s o f th ese eco n om ies. D a ta produced b y sta tis tic a l offices o f th e c e n t r a l l y -
p lan n ed (economies is not only its e lf u nreliable, bu t a fte rw a rd s, in th e first y ears o f t r a n s i t i o n
th e co u n trie s exp erienced a lan d slid e, w ith falling G D P and high levels o f in flatio n , t o b e
follow ed by a sp e cta cu la r reb o u n d . T h e refo re th e fig u res, if at all av ailab le, ca n be e x p e c t e d
to b e im p recise. H ence any d a ta b efo re, say, 1993 a r e p ra c tica lly useless, and d a ta fo r t h e
e a rly y e a rs must b e tr e a te d w ith e x tre m e cau tio n . T h is p roblem flaw s th e a c tu a l ch o ic e a n d
c o n s tru c tio n o f th e v ariab les for an a ly sis, m aking th e m fa r from ideal.
As m entio n ed , th e a n a ly sis ta k e s a specific ’o u t o f tim e ' ap p roach , th a t is c o m p a r in g
c o u n trie s w ithin a c e rta in p erio d (years) befo re jo in in g th e cu rren cy u nio n . H en ce f o r
in sta n c e , assu m ing th e C E E C s a im for entering th e Eurozone? in 2 0 0 7 , th e a n a ly sis c o n d u c t e d
for a y ears prior to m e m b ersh ip will com p are 2 0 0 2 d a t a for th e accessio n co u n tries, 1 9 9 0
d a ta fo r G re e ce and 1991 d a ta fo r th e o th e r E M U s t a te s .
As th e r e is no obviou s way t o d iscrim in a te a g a in st «inch o th er the* c r ite r ia used in t h i s
a n a ly sis , tin ts all th e v a ria b le s h av e b een stand ard ized by su b tra c tin g th e m ean and d iv id in g
by th e re sp e c tiv e sta n d a rd d e v ia tio n .
1.4.1 Real Convergence Variables
A s seen b efo re, O C A lite ra tu re su g g e sts a n u m ber e>f featu re's which m ake a co u n try m ore?
likely to be? su ita b le for co m m o n c u rre n c y m em bersh ip . T h e variables ch osen for o u r a n a ly s is
1*
in teg ratio n and inflatio n ra te . T h e first tw o o f th e a b o v e a r e m easured w ith re sp ect to
G erm any, thu s we a re in a sense asse ssin g th e s u ita b ility o f co u n tries to ad opt a co m m o n
cu rre n cy to g eth er w ith G erm any. T h e referen ce c o re used la te r for th e c a lc u la tio n o f th e
O C A in d ex will b e G erm any.
T h e bu siness c y cle v ariab le is in fa c t m ore o f a m e asu re o f co rrelatio n o f in d u strial
p rod u ction flu ctu atio n s, due to th e fa c t th a t , as e x p lain e d ab o v e, sh o rtn ess o f th e sam p le
lim its th e e stim a tio n o f bu siness cy cle s for th e C E E C s . T h e reference is G erm an y , an d th e
co rrelatio n is based on sm o o th ed (H P -filte r ) m o n th ly d a ta over a period o f 8 y ears, th u s due
to th e sh o rtn ess o f th e sam p le does not. vary over tim e - a sim p lificatio n n ecessary to avoid
th e d isru p tive influence of e a rly 199 0 s d a ta for th e C E E C s , and co m p arab ility w ith E M U
-11. T h e real exchange! ra te v o la tility a g a in st G erm an y is ca p tu re d by m o n th ly o b serv atio n s
over 2 y e a r m oving windows. L a b o r m a rk et fle x ib ility is proxied by a m easu re o f th e ease
o f new jo b creat ion - an ag g reg ate in d ex create d u pon v a ria b le s such a s th e d u ra tio n and
co m p lex ity o f new business re g istra tio n p ro ced u res, as well as th e cost o f th e se p ro ced u res
and m inim um c a p ita l required re la tiv e to G N I. A n o th e r su gg ested proxy was em ploym ent
p ro tectio n leg islatio n , w hich w as not used d u e to th e fact th a t it would b e m easu rin g som e
dem aní 1 side fle x ib ility - am bigu ou sly re la te d to th e c a p a b ility o f th e la b o r m ark et to ad ju st
to sh o ck s. It seem s indeed u n cle a r w h e th e r m ore s tr ic t em p lo y m en t p ro te ctio n would lead
to less severe effe c ts o f n eg ativ e sh o ck s o n econom y, or c o n tra rily slow down th e speed o f
ad ju stm en t and lead to m ore p e rsisten t sh o ck s. T h e d eg ree o f tra d e in teg ra tio n is m easured
as th e sh are o f tra d e d one w ith th e c u rre n t E M U m em b ers. T h e A ccessio n C o u n tries,
though not fo rm ally E U m em bers e x h ib it relativ ely hig h in teg ratio n w ith th e E u ro -1 1 3
co m p a ra b le w ith th a t o f cu rren t m e m b e rs. A m o re p recise d escrip tion o f th e d a ta sources J By Euro-11 we denote the EM U excluding Luxembourg, for which data are unavailable.
2 9
W l i i A l
an ti v ariab le s c re a tio n can b e fourni in A p p en d ix A. A m ong th e in te n tio n s o f th e r e a l - s i d e
a n a ly sis is th e co n stru c tio n o f a S u ita b ility In d ex - a o n e d im ensional m e a su re c a p t u r i n g
th e re la tiv e su ita b ility o f a co u n try , acco rd in g to O C A theor>r, for th e E u ro z o n e.
1.4.2 Nominal Convergence Variables
T h e ch o ice o f in d icato rs in o rd er to m easure th e read in ess o f count ries in te rm s o f M a a s t r i c h t
c r ite r ia is relatively stra ig h tfo rw a rd . D a ta for in fla tio n , m onthly ex c h a n g e r a te ag ain st t h e
E C U and eu ro , budget deficit and public d ebt a re g en erally av ailab le. T h e long t e r m
in terest ra te on government, b o n d s poses a m ino r a v a ila b ility p roblem in th e ease o f t h e
c a n d id a te co u n tries, and th u s lias b m i proxied, for b o th M em ber S ta te s and A c c e s s io n
C o u n trie s, by th e average* m ark et lending ra te . In o rd e r to in tro d u ce referen ce poin ts, t w o
d u m m ies have been added -
D u m m y {
0) with all th e v ariab le s set to zero andD u r n m y ( M C )
w ith all v ariab les set to m a rg in a lly fulfilling th e M C . T h e s e will form a b en ch m a rk for t h o
a sse ssm e n t, as tin 1 set o f co u n t ries does not provide a ap p ro p riate referen ce. C o n tra ry t o
th e cast? o f real co n v erg en ce c r ite r ia w here it serves th is p u rp ose, G erm an y is not p e rfo rm in g
e x c e p tio n a lly in term s o f n o m in al crite ria fu lfillm en t, tliu s tin?
Durtmiy(Q)
serves for t h i s p u rp o se, w h ileD u m m y ( M C )
servos as a c u t-o ff value, h i o th e r w ords, b ein g classifuM f a r from G erm a n y , in term s o f th e n o m in al v ariables, would not n ecessarily m ean p e rfo rm in gw orse th a n G erm any . In o rd er to c a p tu re co u n trie s th a t score b e tte r on th o M a a s tr ic h t
c r ite r ia th a n obliged , we ad o p ted
D urn m y(
0) a s th e re fe ren ce value, w hileD u i n m y ( M C )
is th e fu rth e st aw ay in te rm s o f a ll req u irem en ts, am ong th e co m b in a tio n s s till satisfy in g t h et reaty .
Tin* d e ta ils co n cern in g th e c r e a tio n o f th e v ariab le s a r e presented in A p p en d ix A . O n e o f
measure to score the readiness of countries to fulfil the Maastricht requirements.
1.5
The M ethodology
F o r e a c h o f th e tw o sets o f c rite ria , th e analysis co n sists o f tw o p arts and th e re su lts art?
su b seq u en tly co m p ared . In th e first s te p , th e fuzzy clu ste rin g algorithm is applied t o search
for a p a tte rn in th e d a ta . S eco n d , p rin cip al co m p on en t a n a ly sis is used in an a tte m p t to
sim p lify th e m u ltiv a ria te d a ta set w ith th e in ten tio n o f c r e a tin g a relative o n e-d im en sio n al
m easu re.
1.5.1 Fuzzy Clustering Algorithm
T h e fuzzy clu ste rin g alg o rith m used to p a rtitio n th e d a ta , c a n be seen in m ore d e ta il in
K a u ffm a n and R ousseeuw (1 9 9 0 ) o r in H oppner, K law onn, K ru se and H u nkier ( 1 9 9 9 ). T h e
ex act m eth o d em ployed is th e c -m e a n s m eth o d proposed by D u n n (1974) and B ez d e k (1 9 7 4 ).
T h is follow s th e work o f A rtis and Z h an g (2 0 0 2 ) and B o re ik o (2 0 0 3 ).
In o u r ca se , th e d a ta set co n sists o f
u
co u n tries, andp
variables. E a c h o b je c t a** is ch a ra cte riz ed by a v ector o f featu re s (aq — { x u , .., x i;>} fori
= 1..??), w here each v ariable is stan d ard ized w ith moan zero and u n it varian ce. T h e d issim ilarity ind exd { i , j )
is the E u c lid ia n d ista n c e bctw<?en th e tw o o b je c t s x* and x_, in p -d im ensional sp ace:(1)
T h e o b je c tiv e o f th e alg o rith m is to m inim ize th e follow ing o b je c tiv e fu n ctio n
