II.1 Moving to monetary union
Since the resolution of the Russian crisis of 1998, an event that had pronounced repercussions for several neighbouring countries, the growth rates of the recently acceded Member States of central and Eastern Europe (RAMs)1 that joined the EU in 2004 have comfortably outpaced those of most of the EU-15. After the adverse shock of the early transition period when every country endured falling output and high inﬂation, most countries saw a bounce back in activity. This return of rapid growth in all the RAMs since the late 1990s (when, in addition to the Russian crisis, other asymmetric shocks of varying kinds had slowed growth) has resulted in an impressive degree of real convergence in GDP in recent years. Indeed, among the EU-15, only Greece and Ireland have had growth rates comparable with the RAMs since 2000 and, as Table 3.1 shows, the fastest growing RAMs have grown at four to ﬁve times the rate of the euro area as a whole. The convergence is consistent with what would be expected from the many studies triggered by the work of Barro and Sala-i-Martin (1992). However, as can be seen from Table 3.1, although the gap in GDP per head has narrowed, it remains substantial and bridging it will remain a challenge. All the new members are expected to become full members of EMU, which will require
them to fulﬁl the nominal convergence criteria. For some, current values for the relevant indicators suggest that there will be few problems in this regard, but for others a more extensive adjustment will need to occur. Nevertheless, for all the RAMs, the extent of the nominal adjustment they face to be eligible to move to stage 3 of EMU is not only manageable, but is also less than that which confronted some of the current members of the euro area at the time the Maastricht Treaty was signed as well as in the mid-1990s. A successful transition to euro area membership will, though, entail far more than
meeting the Maastricht criteria. A change of monetary regime, especially one as far-reaching as adoption of the euro, will have profound eﬀects on the real economy and will also aﬀect ﬁnancial markets in ways that could imperil ﬁnancial stability. Moreover, there are potential tensions between the catch-up process (real convergence) and the achievement of the nominal convergence criteria that could aﬀect the political economy of how and when to seek full participation in EMU. Financial stability2 has been recognized as a crucial factor in promoting long-term
growth and is, therefore, bound to be an issue in both catch-up and euro accession. Its importance has been underlined by the ECB (2005a) and is also evident in the increasing attention paid to it by the relevant authorities. That the RAMs are alert to the challenges of ﬁnancial stability is evident from the increased emphasis it receives in the priorities of the respective national central banks. The Czech National Bank, for example, highlights on its web-site the fact that it ‘commenced ﬁnancial stability analysis in earnest when it deﬁned the priorities of its economic research for the period 2003-4 and published the Banking Sector
Stability Report for 2003’ and now publishes an annual ﬁnancial stability report. Major causes for concern are the quality of prudential supervision, the potential for a rapid increase in consumer debt and how it might compromise macroeconomic stability, and the relatively under-developed banking sectors in the RAMs. The next section of the chapter examines the challenges associated with acceding to stage 3
of EMU and in striking a balance between the long-term gains from EMU and the shortterm risks to real convergence, highlighting the salience of ﬁnancial stability. The following sections look at what is entailed in adjusting to EMU prior to accession (stage 2 adjustment) and once fully integrated (stage 3 adjustment). Next the links between real convergence and ﬁnancial stability in the EMU context are appraised. Concluding comments complete the chapter.