The Convergence of Monetary Policy between Candidate Countries and the European Union

Abstract

The successful accession to membership in the European Union (EU) by the current transition-economy applicants, the Czech Republic, Hungary, the Slovak Republic, Slovenia and Poland, will depend to a large extent on their ability to align themselves with the institutions and the macroeconomic policies of the EU. In this paper, we examine whether these countries will be able to achieve the necessary stability between their exchange rates and those of their EU partners. We do this by investigating the extent to which they have been able to achieve some measure of convergence between the evolution of their money supply and that of Germany, which we use as a historical proxy for the future monetary policy stance of the European Central Bank (ECB). We also compare the convergence achieved by these five transition-economy candidate countries to that achieved by countries that have recently become members of the EU, by several non-transition candidate countries as well by some transition economies. The sample period covers the post-93 period.

Based on the cointegration and error correction estimations, our results show significant long- and short-run linkages between the Bundesbank, which we see as a proxy for the ECB, and the most recent members of the EU, Austria, Finland and Sweden. We also find a strong connection between the Bundesbank's policies and those of Cyprus and Malta, two of the market economy candidates for EU membership. Among the transition economies, the ability to follow the policies of the Bundesbank is weaker or, for some countries, not in all cases those that are the most backward in their stabilization and transformation efforts, nonexistent. While we cannot conclude that the failure to follow the Bundesbank's monetary policy closely or not at all by the transition economies is an absolute barrier to their joining the EU, such weak policy coordination may reflect the need for a further building up the financial sectors of these countries as well as the need for a period in which these countries do tie their policies more closely to that of the ECB before they join the EU.