Monetary Independence of Central and Eastern European Economies with Flexible Exchange Rate Regimes

Abstract

According to the macroeconomic trilemma, the floating exchange rate regime provides room for monetary independence. The paper examines whether this is the case in CEE economies. The ARDL bounds tests are used. A level relationship between domestic and euro interest rates is found in all CEE countries, although evidence for Hungary is weak. It is demonstrated that the crude monetary independence indices do not capture the relevant relationship adequately. It is concluded that the Czech Republic and Poland will be able to retain monetary independence when the ECB embarks on the tightening its monetary policy, but not Hungary or Romania.

Keywords:

• ARDL bounds tests
• exchange rate regime
• macroeconomic trilemma
• monetary policy autonomy
• quantitative policy modelling

JEL Classification:

• F41
• F33
• E44
• C54

Acknowledgments

The authors acknowledge financial support from the National Science Centre in Poland (grant no. DEC-2015/17/B/HS4/02681). The authors are grateful to the participants of the conference on ‘Economic Turmoil In Contemporary Europe III’ at the Lazarski University and at the 12th Professor Aleksander Zelias International Conference on ‘Modelling and Forecasting of Socio-Economic Phenomena’ for useful comments.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. In the Introductory Statement at the press conference on 13 December 2018, one can read “we intend to continue reinvesting, in full, the principal payments from maturing securities purchased under the APP for an extended period of time past the date when we start raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation” (ECB 2018).

2. To be precise, we assume that the target exchange rate remains fixed, so ${\bar{s}}_{t+1}^e={\bar{s}}_t$. If it is not the case, because, for example, the central bank gradually depreciates its currency (a crawling peg/band arrangement), a constant term should be added to the expression in brackets. In the empirical part, we indeed allow for a constant in the estimated equation.

3. In the case of a crawling peg, ${\bar{v}}_{t+1}^e=const$.

4. Up to five lags are allowed for each variable in the model.

5. For example, either the risk premium or output gap is not even observable.

6. As explained by PSS (2001), the possibility of a degenerate level relationships between $y_t$ and $x_t$ is admitted under the alternative hypothesis since it covers the case ${\pi }_{yy}\ne 0$ and ${\pi }_{yx.x}=0^{\prime }$ as wells as ${\pi }_{yy}=0$ and ${\pi }_{yx.x}\ne 0^{\prime }$.

7. At the Global Investment Conference in London on 26 July 2012, Draghi said “[w]ithin our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough” (Draghi 2012).

8. To save space, the full results are not reported, although they are available upon request.

9. Moreover, Poland was classified as having a “dual market in which parallel market data is missing” in 1993 and 1994.

10. For more on shadow interest rates, see, e.g., Krippner (2014), Wu and Zhang (2017), Lemke and Vladu (2017).

11. In fact, the interest rate in the Czech Republic fell below 1% as early as in September 2012, in Hungary in May 2016 and in Romania in November 2015. In Poland, the interest rate remained at around 1.7% after March 2015.

12. The full results are available upon request.

13. See Rey 2018/2015. The paper was presented at the Economic Policy Symposium in Jackson Hole in 2013.

Additional information

Funding

This work was supported by the National Science Centre in Poland [DEC-2015/17/B/HS4/02681].