Perspectives on Financial, Monetary, and Economic Developments in Eastern Europe

This special issue of Eastern European Economics includes a selection of articles presented at the INFER Workshop on Rethinking Development and Macroeconomic Policy on April 20–21, 2017 in Cluj-Napoca (Romania) and at the 19th INFER Annual Conference at the University of Bordeaux (France) on June 7–9, 2017.

These two INFER events brought together academics, practitioners, and public officials for a dialogue on development and macroeconomic policies in the wake of the recent crises. Numerous research presentations on the European countries were given. Some of the presented articles put a specific focus on the Central and Eastern European Countries (CEECs). This special issue entitled “Perspectives on Financial, Monetary, and Economic Developments in Eastern Europe” is composed of five of these articles. They analyze key challenges faced by the CEECs on their way to a deeper European integration in the context of the recent financial and debt crises. Fiscal and monetary policies, banking system development, current account dynamics, as well as the impact of exchange rates on trade are precisely the issues considered by the articles included in this special issue.

In Europe, the issue of money demand has been brought to the forefront of the debate, through the creation of the European Monetary Union (EMU) and the enlargement of the European Union (EU) and of the EMU further on, to the Central and Eastern European countries (CEECs). Some of the CEECs have not yet joined the EMU, but have started the preparation of their future monetary integration. This implies that a specific focus has been put on the development of monetary aggregates, which constitute the “monetary pillar” of the European Central Bank (ECB) monetary strategy. Within this framework, the determinants and stability of the money demand become crucial (Fidrmuc 2009). The article cowritten by Valentina Mera and Monica Pop Silaghi, entitled “Money Demand Determinants in CEE Countries—Updated Evidence,” analyzes the money demand in six CEECs (Bulgaria, Croatia, the Czech Republic, Hungary, Poland, and Romania) that are EU members but have not yet adopted the single currency. Several factors are considered as main determinants of money demand in these countries: real GDP, inflation rate, interest rate, and exchange rates. The authors use quarterly data (1996–2016) and employ an ARDL Bounds Testing Approach technique in the spirit of Pesaran, Shin, and Smith (2001). They find a cointegration relationship between money demand and its determinants for all countries except Bulgaria and Croatia. Within this framework, the existence of a currency substitution effect is identified in Bulgaria, Croatia, and Hungary while a dominant wealth effect is spotted in the Czech Republic. Some specificities, in terms of magnitude and direction, of the long-run relationship between money demand and its determinants in the six CEECs are also identified. They can be explained by the economic recession in the Eurozone and in the CEECs as well as by different monetary policy measures implemented during the financial crisis in the considered countries.

The financial crisis of 2008–2011 has also led to the creation of a real estate bubble in most of the European countries, especially in those from the EU periphery. This induced an increase of the current account deficits in the EU member states. The article by Irina Ban, entitled “House Prices and Current Account Evolution in the European Union: An Intertemporal Approach,” tackles this issue using, in a first stage, an intertemporal current account model. The article takes a step further and focuses on the current account determinants of EU countries over the period 2000–2014 by using a GMM estimator and annual data. In this respect, following Bussière, Fratzscher, and Müller (2004), the author takes account of the role played by fiscal balance, GDP growth rate, investment (% GDP), government expenditure (% GDP), and net output variation in explaining the current account deficit. Several other explanatory variables such as the structural budget balance, house prices, a real effective exchange rate, and a crisis dummy are included among the regressors. The results confirm the “twin deficits” theory: this suggests that fiscal and external imbalances in the EU members are correlated. The author also shows that countries with a lower per capita income and a higher investment rate, namely the CEECs, compared to historical EU members, tend to have larger current account deficits. Within this framework, a specific focus is put on the impact of houses prices on the current account evolution (i.e., the higher the price of the real estate property, the higher the wealth, which leads to an increase of consumption of both domestic and foreign goods, which may increase the current account deficit). Using different house price indexes, the author shows that the last asset price bubble, which expanded before 2008, has worsened the external imbalances in the EU economies. This is because rising asset prices induced a wealth effect that encouraged consumption instead of savings. In this context, interaction terms are used in order to capture the asymmetric impact of houses prices for different groups of EU members (i.e., economies with a chronic deficit and those with a chronic surplus; EMU and non-EMU countries; CEECs and non-CEECs). The results underline that the last asset price bubble had a much smaller effect on external imbalances in the surplus and EMU countries, but it heavily deteriorated the current account balance of deficit and non-EMU economies. Furthermore, the negative impact of the last asset bubble on external imbalances seems to be driven mainly by the situation of the CEECs. This outcome calls for a better regulation of the housing and the capital markets in the CEECs in order to avoid a housing bubble that can have a negative impact on the fiscal balance and on the current account further on.

The challenge posed by foreign exchange (FX) assets and liabilities for macroeconomic stability is analyzed in the article written by Alin Andries and Simona Nistor, entitled “Systemic Risk and Foreign Currency Positions of Banks: Evidence from Emerging Europe.” Compared with loans in local currency, the amount of foreign currency denominated loans, characterized by lower interest rates, increased dramatically the balance sheets of banks, especially in the last decade. The authors underline, for example, that the ratio of foreign currency denominated lending to total lending was 3% for the Eurozone, while for the non-Euro area it was equal to 37% at the beginning of the 2008 financial crisis. As a common phenomenon in Central and Eastern European Countries, a boom of Swiss franc (CHF) lending was identified during 2007–2008. Within this framework, the authors investigate the impact of foreign currency denominated assets and liabilities on systemic risk using a unique hand-collected dataset of bank-level FX positions for the period 2005–2012. The sample consists of banks from Central and Eastern Europe with large shares of FX exposures on the balance sheet. The systemic risk estimates are based on the CoVaR (Conditional Value at Risk) and MES (Marginal Expected Shortfall) methodologies. Empirical findings indicate that systemic risk measures are highly impacted by the currency choice of financial institutions. While FX positions denominated in EUR and USD do not pose systemic risk concerns, FX positions denominated in exotic currencies like CHF significantly enhance the systemic importance of the banks. The negative influence of CHF positions might be reduced through prudent corporate governance mechanisms, tight restrictions on banking activity, and more restrictive limits on foreign currency lending in the home countries of bank holding companies.

Jana Simakova deals with yet another aspect of the CEECs European integration—the effects of the exchange rate against the euro on trade. In the article “Asymmetric Effects of Exchange Rate Changes on Foreign Trade of the Czech Republic,” she investigates this issue in the case of a specific CEEC, namely, the Czech Republic. The analysis is conducted over the period 1999Q1−2014Q4, using a nonlinear version of the ARDL cointegration techniques. The author examines the effects of an exchange rate depreciation/appreciation on the Czech Republic trade of ten commodities in relation with five major trade partners (Germany, Slovakia, Austria, France, and Italy). The originality of the approach is two-fold. First, the author shows that in the Czech Republic, the exchange rate changes can have asymmetric effects on the trade balance (i.e., in theory if a depreciation is expected to enhance exports and diminish imports, while an appreciation is expected to have the opposite effect, the results might not be as expected and a J-curve can emerge). In particular, the article underlines that in the Czech Republic, the reaction of producers, sellers, and traders to a currency depreciation can be different not only in sign but also in size compared to the one in relation to an appreciation, depending on the sector, the time period, and the trading partner. Second, the policy implications of the article are underlined: the results can be put forward into a different light when assessing the potential outcomes of abandoning the national currency (and exchange rate) on the way to European monetary integration.

After the sovereign debt crisis in Europe, countries’ debt sustainability has been one of the central issues discussed in terms of economic policy, not only in relation to the countries that were subject to rescue programs like Greece, Portugal, and Ireland but also to other European countries in general (i.e., Central and Eastern European Countries in particular). Hence, the number of studies on debt sustainability has increased exponentially in the last years; however only few of them have put a focus on the CEECs. The article by Bettina Bökemeier and Andreea Stoian, entitled “Debt Sustainability Issues in Central and East European Countries,” aims to fill this gap, by extending Burger’s methodology (see Burger et al. 2011; Burger 2012) and computing the stable level of debt ratios, the turning points, and the debt limits of “fiscal fatigue” for the CEECs. The authors use data for Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia, from 1998 to 2015. They find that the debt to GDP ratios of all countries were above the stabilization level, though, all of them were below the level beyond which countries exhibit fiscal fatigue. Hence, all debt ratios had a stable dynamics, converging to a stable level. Therefore, it can be concluded that all the CEECs today have a sustainable public debt. Nevertheless, the authors warn that these results should be taken with caution as they simply reflect the current situation and not future developments following the fiscal decisions of governments nowadays. The authors underline also that two countries might exhibit some alarming signals: Slovenia and Romania. The former is dangerously close to the “fiscal fatigue” point and to the unstable area. In the case of the latter, the projected surplus is lower than expected and might be insufficient to stabilize the public debt in 2018. This suggests that Romania’s government may find it difficult to implement further adjustments if necessary.

This special issue provides an up-to-date picture of the economic, monetary, and financial dynamics of the Central and Eastern European countries. We have chosen to focus on these countries in particular for two reasons. First, the political decision to enlarge the European Union to ten CEECs in 2004, then to include Bulgaria and Romania in 2007, and Croatia in 2013 as well as the recent economic and financial crises put the Central and Eastern member states in a new situation, which has challenged their ability to adapt to a changing European and global environment. Second, at the European level, the 2004 enlargement planted the seeds of an EMU widening toward the East. However, the EMU crisis and all the economic problems that it brought along underlined the importance of undertaking a careful screening process when further enlarging the Eurozone. If in calm periods, the heterogeneity among countries does not seem to be a major concern, in crisis times, macroeconomic divergences might worsen. It is obvious that Europe, in general, and the CEECs, in particular, continue to face challenges at the macroeconomic level. Nevertheless, there are clear signs that European countries are committed to take further steps to make the European integration process and the monetary union sustainable (De Grauwe 2018).

Acknowledgments

The authors thank Eastern European Economics, and the editor, Josef Brada, for providing an authoritative outlet to these conference papers. The financial support from LEO/CNRS—University of Orléans and INFER is gratefully acknowledged. INFER (International Network for Economic Research) is a nonprofit organization supporting research in all areas of economics. It encourages young researchers to present and publish their work. It also stimulates networking activities amongst scholars and it facilitates the dissemination of new ideas by organizing conferences and workshops on various topics in economics and by organizing special issues following INFER events.