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Abstract:
This paper analyzes the link between the choice of exchange rate regime and inflationary performance in four acceding countries to the EU: the Czech Republic, Hungary, Poland and Slovenia. The results allow a clear ranking of countries according to the size of the pass-through effect and the importance of exchange rate shocks to overall inflationary performance. In particular, perfect pass-through effect can be associated with accommodative exchange rate policy, which can moreover become the most important source of inflationary pressures. The analysis suggests that for CEEC-4 an early adoption of the Euro can provide the most efficient framework for reducing inflation.

EMU accession, pass-through effect, I(2) cointegration analysis, policy accomodation

Abstract:
Recent literature on the interactions between labor unions and monetary institutions features either a supply or a demand channel of monetary policy, but not both. This leads to two opposing views about the effects of central bank conservativeness. We evaluate the relative merits of those conflicting views by developing a unified framework. We find that: (i) the effect of conservativeness on employment depends on unions' relative aversion to unemployment versus inflation, and (ii) for plausible values of this relative aversion (and more than one union), social welfare is maximized under a highly conservative central bank. We also evaluate the effects of centralization of wage bargaining and product market competition on unemployment and inflation.

Abstract:
Existing literature on the strategic interaction between the central bank (CR) and unions assumes that firms face perfect competition on product markets and that inflation is chosen directly by the monetary authority. Although these simplifications have the virtue of making complex strategic interactions more tractable, they abstract from the fact that, in reality, prices are set by firms and that the monetary authority affects the price level and inflation by determining the money supply. This paper makes a step in the direction of realism by recognizing that prices are set by monopolistically competitive firms and that the monetary authority affects the price level and inflation indirectly through its choice of money supply. This is done in a three stage game, in the first stage of which unions contractually set nominal wages, in the second stage the CB chooses the money supply, and in the third stage each firm chooses its individually optimal price. A sample of the paper's results follows: 1. In spite of full price flexibility, changes in the degree of conservativeness of the CB affect employment and output even when inflation is fully anticipated by labor unions and even when unions are indifferent to inflation. 2. When the CB is sufficiently conservative it reduces the money supply in response to wage increases. Both casual and econometric evidence suggests that such a mechanism has been in evidence in Germany where the Bundesbank often tightened monetary policy in response to "excessive" wage settlements. 3. Recent results concerning the optimality of a populist or "ultra liberal" CB are shown to be the exception rather than the rule. In particular, in many circumstances, an ultra conservative CB reduces both inflation and unemployment sufficiently to make the appointment of such a bank socially optimal. Intuitively when the CB is more conservative each union correctly anticipates a stronger contractionary reaction to an increase in its wage and, therefore, a stronger increase in unemployment among its members. As a consequence, the deterring effect of unions' fears from unemployment on their wage demands is stronger and employment higher when the CB is more conservative.

Abstract:
Using both macro and industry-level data this paper analyses the nonlinear effects of financial development and international financial integration on economic growth in Europe. Special attention is devoted to modeling threshold effects with respect to the depth of financial markets as a measure of economies' absorption capacity. Results reveal evidence of significant non-linear effects, with less developed European countries gaining more from financial development. In contrast, benefits of international financial integration become significant at higher levels of financial development. The data show that monetary integration in Europe significantly contributed to a higher degree of financial integration. Entry of new EU members to the European Monetary Union may thus be the mechanism ensuring a virtuous development circle, as the adoption of the Euro may allow the development of domestic financial markets and financial integration to go hand-in-hand.

Euro adoption, financial integration, financial development, threshold effects, economic growth

Abstract:
This paper develops a model of the process of reallocation of labor from the state sector to the private sector. When growth is exogenously determined, we show that in the initial stages of transition unemployment will rise over time. After a critical stage in the transition process, restructuring is accompanied by a decline in unemployment. When growth is endogenously determined, and human capital is acquired by learning-by-doing, we show that whether restructuring eventually occurs is determined by the level of human capital in the private sector and the rate of unemployment. The effects of various shocks and government policies in affecting the costs, speed, and eventual outcome of restructuring are analyzed.

Abstract:
This paper surveys recent advances in empirical studies of the monetary transmission mechanism (MTM), with special attention to Central and Eastern Europe. In particular, while laying out the functioning of the separate channels in the MTM, it explores possible interrelations between different channels and their impact on prices and the real economy. The empirical findings for Central and Eastern Europe are then briefly compared with results for industrialized countries, especially for the euro area. We highlight potential pitfalls in the literature and assess the relative importance, and potential development, of the different channels, emphasizing the relevant asymmetries between Central and Eastern European countries and the euro area.

monetary transmission, transition, Central and Eastern Europe, credit channel, interest rate channel, interest-rate pass-through, exchange rate channel, exchange rate pass-through, asset price channel

Abstract:
This essay surveys macroeconomic issues that marked the transition from centrally planned to market economy in Central and Eastern European and former Soviet Union countries. We first establish a set of stylized facts of the transition so far, namely: (1) output fell, (2) capital shrank, (3) labor moved, (4) trade reoriented, (5) the structure changed, (6) institutions collapsed, and (7) transition costs. We then critically survey the theoretical literature on transition, discussing various explanations for the initial output fall as well as medium term issues, such as optimal speed of transition, disorganization, institutions and sectoral reallocation as a source of output dynamics. Last, we review the empirical literature to assess how well it translates the theoretical models and explains the stylized facts. The essay concludes with a succinct list of suggestions for future research.

Economic Growth, Transition Economies

Abstract:
This essay surveys macroeconomic issues that marked the transition from centrally planned to market economy in Central and Eastern European and former Soviet Union countries. We first establish a set of stylized facts of the transition so far, namely: (1) output fell, (2) capital shrank, (3) labour moved, (4) trade reoriented, (5) the structure changed, (6) institutions collapsed, and (7) the transition costs. We then critically survey the theoretical literature on transition, discussing various explanations for the initial output fall as well as medium term issues, such as optimal speed of transition, disorganization, institutions and sectoral reallocation as a source of output dynamics. Last, we review the empirical literature to assess how well it translates the theoretical models and explains the stylized facts. The essay concludes with a succinct list of suggestions for future research.

Transition, growth, Central and Eastern Europe, former Soviet Union, stylized facts

Abstract:
The relationship between economic and political liberalization has received a great deal of attention lately, yet the possibility of a non-linear relationship and the role of reversals remain largely neglected. Focusing on democratization and financial reform, this paper offers evidence for a U-shaped relationship across countries, over time as well as in a panel setting using a wide range of estimators for various reform measures. We link this non-linear relationship to the notion of partial or captured democracy. We provide as well econometric support showing that even when de facto is modelled as a function of de jure financial liberalization, this non-linearity obtains.

economic liberalization, financial reform, political liberalization, reform reversals

Abstract:
The relationship between economic and political liberalization has received a great deal of attention lately, yet the possibility of a nonlinear relationship and the role of reversals remain largely neglected. Focusing on democratization and financial reform, this paper offers evidence for a U-shaped relationship across countries, over time as well as in a panel setting using a wide range of estimators for various reform measures. We link this non-linear relationship to the notion of partial or captured democracy. We provide as well econometric support showing that even when de facto is modelled as a function of de jure financial liberalization, this non-linearity obtains.

reform reversals, political liberalization, economic liberalization, financial reform

Abstract:
Countries of central eastern Europe which are candidates for accession to the European Union face fundamental challenges in the conduct of macroeconomic policies. These countries are characterized by growth rates faster than those of EU countries, along with large current account deficits and an equilibrium appreciation of the real exchange rate. In such a context, an early adoption of the euro may be beneficial to central eastern European countries, while the ERM-II system and the Maastricht criterion on inflation may give rise to serious drawbacks for candidate countries.

Abstract:
Most empirical studies on price setting that use micro data focus on advanced industrial countries. In this paper we analyze the experience of an emerging economy, Slovakia, using a large micro-level dataset that accounts for a substantial part of the consumer price index (about 5 million observations). We find that market structure is an important determinant of pricing behavior. The effect of market structure on persistence of inflation results from two conflicting forces. Increased competition may reduce persistence by increasing the frequency of price changes. In contrast, higher competition may increase persistence through inertial behaviour induced by the strategic complementarity among price setters. In our case study, we find that the latter effects dominate. Indeed, the dispersion of prices is higher while persistence is lower in the non-tradeable sectors, suggesting that higher competition is not conducive to lower persistence. Furthermore, we find that the frequency of price changes depends negatively on the price dispersion and positively on the product-specific inflation. These results seem consistent with predictions of Calvo's staggered price model.

price setting, market structure, emerging markets

Abstract:
The paper analyzes the macroeconomic implications of different systems of industrial relations. After reviewing the relevant literature, and analyzing cross-country evidence, the paper focuses on the experience of centralized bargaining characterizing Spain in the period 1979-86. The paper argues, in accordance with the literature and the cross-country evidence, that the centralization of bargaining yielded positive macroeconomic effects in Spain, and thus that the shift toward a more decentralized setting after 1987 carries several risks. This conclusion is based on an empirical analysis of the wage setting process and of the evolution of labor shares in income.

Abstract:
This Paper develops a framework for the analysis of the effects of institutions on economic performance in a monetary union in the presence of stabilization policy, unionized labour markets and monopolistically competitive price setting firms. Nominal wages are fixed contractually. In spite of full price flexibility transmission of monetary policy operates via both aggregate demand and aggregate supply channels. The Paper relates average, as well as country-specific economic performance within the monetary union, broken down to country size, number of unions, the degree of product differentiation on product markets, and central bank conservativeness. Economic performance is characterized by unemployment, inflation, real wages and competitiveness. Both average, as well as country-specific, economic performance in the presence of (possibly) heterogeneous shocks and a unified stabilization policy are evaluated.

Central bank conservativeness, monetary union, monopolistic competition, shocks, stabilization, stabilization policy, wage bargaining

Abstract:
Retail lending grew very fast in the New Europe region in the last years, prompting a debate on whether such a rapid growth can be considered sustainable. This paper investigates the main determinants of retail lending growth throughout the region. It tries to identify episodes of credit boom and analyzes the possible correlation between such booms, consumption booms and a country external account position. Estimating an aggregate consumption function, under the assumption of liquidity-constrained households, the paper finds that current trends in household credit markets largely reflect an equilibrium phenomenon, in which household credit increases rapidly from extremely low initial levels, in the context of a relaxation of liquidity constraints. The rate of growth of credit responds to changing market conditions on the supply side and to good prospects for income growth. In such an environment, loosening credit market conditions can have sizable effects on consumption, which, in some cases may create macroeconomic imbalances, both in terms of current account deficits and inflationary pressures.

Credit booms, household credit, new members of the European Union

Abstract:
In this Paper we analyse the link between the choice of exchange rate regime and inflationary performance in four EU accession countries: the Czech Republic, Hungary, Poland and Slovenia. Estimation of pass-through effect of exchange rate changes to CPI inflation is complemented by I(2) co-integration analysis of stochastic nominal trends. The results allow a clear ranking of countries according to the size of the pass-through effect and the importance of exchange rate shocks to overall inflationary performance. In particular, we find that perfect pass-through effect can be associated with accommodative exchange rate policy, which can moreover become the most important source of inflationary pressures. The analysis suggests that for CEEC-4 the early adoption of the euro can provide the most efficient framework for reducing inflation.

I(2) co-integration analysis, EMU accession, pass-through effect

Abstract:
Real exchange appreciation has been a common feature in transition economies since the launching of stabilization and reform programs at the beginning of the 1990s. Previous literature has described this phenomenon as an equilibrium adjustment that followed a sharp undervaluation at the start of the reforms. This Paper argues that real appreciation had different sources over time and across countries. Building on a simple analytical framework, the Paper disentangles these differences and stresses the role of structural reforms and factor reallocation in determining the behavior of the real exchange rate. The empirical results show that the nature of the real appreciation was significantly different in the countries of the Former Soviet Union (FSU), except for the Baltic countries, and in Central and Eastern Europe. The role of structural change and transitional reallocation of resources across sectors diminishes through time, and stabilizes around the fifth or sixth year into the transition. The dynamics of the real exchange rate in several Central-Eastern European countries (CEE) in the process of accession to the European Union, can be now assimilated to that of previously acceding countries such as Spain, Portugal, and Greece, with the Harrod-Balassa-Samuelson effect playing a dominant role at later stages of transition. The Paper concludes by discussing the implications for exchange rate policy for transition economies and potential drawbacks of the Maastricht criteria once CEEs enter the European Union.

Transition economies, real exchange rate, fixed-effects model

Abstract:
We identify the presence of soft budgets and analyse their impact on enterprise restructuring in Romania over the initial transition period. A simple analytical framework is developed to show that hardened budget constraints foster rationalization of costs, but not active restructuring. The latter requires availability of external financing. The model emphasises the importance of the credibility of hard budgets. The empirical findings are consistent with the predictions of the model. Using a sample of over 4,000 Romanian enterprises during 1992-95, we show that hardened budget constraints induce labour shedding. There is no evidence of positive effects on active restructuring, which we define as new investments.

Soft budgets, Romania

Abstract:
We identify the presence of soft budgets and analyse their impact on enterprise restructuring in Romania over the initial transition period. A simple analytical framework is developed to show that hardened budget constraints foster rationalization of costs, but not active restructuring. The latter requires availability of external financing. The model emphasises the importance of the credibility of hard budgets. The empirical findings are consistent with the predictions of the model. Using a sample of over 4,000 Romanian enterprises during 1992-95, we show that hardened budget constraints induce labour shedding. There is no evidence of positive effects on active restructuring, which we define as new investments.

Soft budgets, Romania

Abstract:
The paper provides an empirical analysis of price setting behaviour in Slovakia, using large micro-level dataset covering about 57% of Slovak CPI for the period 1997-2001. The novelty of the paper is the analysis of a country characterized by nearly double-digit inflation and undergoing massive changes in market structure during the process of transition and accession to the EU. Several empirical findings stand out. Similarly to results on advanced market economies, we find that price changes are infrequent and sizeable. Moreover, the relationship between frequency and size of price changes is highly non-linear. Product-specific inflation is typically highly persistent. We find that market structure is an important determinant of pricing behaviour. The dispersion of prices is higher while persistence is lower in the non-tradable sectors, suggesting that higher competition in goods markets is not conducive to lower persistence. An important implication is that increasing market competition brought about by entry in the EU will not necessarily lead to lower persistence. By contrast, the increasing share of services in consumption will reduce persistence. Our results, together with the finding that the frequency of price changes depends negatively on the price dispersion and positively on the individual inflation, seems consistent with predictions of Calvo's staggered price model.

Inflation, inflation persistence, price dispersion, price stickiness, staggered price models

Abstract:
The Paper is one of the first attempts to compute cyclical and structural deficits for a set of countries candidate to accession to the EU. Three main results are derived: first, the high deficits observed in candidate countries in recent years have a structural nature. Second, the fiscal stance has been pro-cyclical in candidate countries. Finally, because of higher volatility of output in these countries, the risks of surpassing the 3% budget limit that applies to all members of the EU are much higher for them. Without changing existing rules in the European Union, it is likely that candidate countries will have to undertake costly and inefficient adjustments of the last minute. Recent proposals by the European Commission would improve matters for candidate countries, without however solving some of their major potential difficulties. The Paper suggests a new fiscal rule for an enlarged European Union, which is consistent with the philosophy of the Stability and Growth Pact but focuses on ex ante limits to expenditure. Such a rule would imply that in periods of growth above trend, countries are forced to run budget surplus, while in periods of economic slack they will run deficits. The rule is fully consistent with the theory of optimal tax smoothing and would, at the same time, strengthen fiscal discipline.

EU enlargement, fiscal rules, golden rule, cyclically-adjusted budget balance, fiscal stance, stability and growth pact

Abstract:
We discuss sources of volatility and vulnerability in the CEECs during the transition and leading up to EU accession. The Paper emphasizes the role of the transition shock as a source of extreme volatility on a much larger scale than the one observed during crises in emerging markets. The low degree of financial and institutional development, which lagged behind the opening of domestic markets to foreign trade, was of paramount importance for the severity of the economic contraction. Pro-cyclical fiscal policy and institutional uncertainties amplified output volatility. Many factors will contribute to more stability in the CEECs in the years ahead. EU integration has given a credibility bonus to the reform efforts of the CEECs, has driven the process of institutional convergence to EU structures, and has led to improvements in the functioning of markets, protection of property rights, contract and law enforcement. Convergence to EU macroeconomic targets has also taken place, reflecting remarkable progress in economic reform, while the deepening of real integration with other EU countries will sharply reduce the magnitude of idiosyncratic shock to CEECs. EU accession criteria will facilitate trade by reducing transaction costs and introducing common standards and continue to attract capital flows. Still, as long as financial markets in the CEECs remain much less developed than those in the EU, output volatility is bound to remain higher in the CEECs than in the EU. Although our analysis indicates that at present the risk of capital flow reversal is low, with their complete liberalization financial capital flow, volatility in the CEECs may increase, and, if not, adequately regulated, financial markets may become more vulnerable to turbulence in international markets. Greater openness of the capital account will constrain the flexibility of the CEECs in using macroeconomic and monetary policy, leaving fiscal policy as the only additional instrument to deal with conflicting domestic and external priorities. The adoption of existing rules in the EU is unlikely to overcome the pro-cyclical stance of fiscal policy displayed by CEECs during the transition period. Off-budgetary expenditures and contingent liabilities that may become explicit government liabilities also pose a risk to state finances.

Volatility, accession countries, under-developed financial markets, pro-cyclical fiscal policy

Abstract:
Current developments in the design and management of fiscal rules in the European Union may have negative implications for New Member States. Loosening of the Stability and Growth Pact (SGP) and a growing degree of arbitrariness in its implementation reduce incentives for fiscal adjustment in New Member States, adjustment that would be crucial during the transition to the Eurozone. High budget deficits may prove a serious obstacle in the process of catching up of New Member States to the income levels of EU-15 countries.

fiscal rules, Stability and Growth Pact, Economic and Monetary Union

Abstract:
The paper provides an empirical analysis of inflation persistence in one of inflation targeting countries, the Czech Republic, using 412 detailed product-level consumer price indexes underlying the consumer basket over the period from 1994 to 2005. Subject to various sensitivity tests, our results suggest that raw goods and non-durables, followed by services, display smaller inflation persistence than durables and processed goods. Inflation seems to be somewhat less persistent after the adoption of inflation targeting in 1998. There is also evidence for aggregation bias, that is, aggregate inflation is found to be more persistent than the underlying detailed components. Price dispersion, as a proxy for the degree of competition, is found to be negatively related to inflation persistence, suggesting that competition is not conducive to reducing persistence.

inflation dynamics, inflation targeting, persistence

Abstract:
The paper provides an empirical analysis of inflation persistence in an inflation targeting country, the Czech Republic, using 412 detailed product-level consumer price indexes underlying the consumer basket over the period from 1994:M1 to 2005:M12. Subject to various sensitivity tests, our results suggest that raw goods and non-durables, followed by services, display smaller inflation persistence than durables and processed goods. Inflation seems to be somewhat less persistent after the adoption of inflation targeting in 1998. There is also evidence for aggregation bias, that is, aggregate inflation is found to be more persistent than the underlying detailed components. Price dispersion, as a proxy for the degree of competition, is found to be negatively related to inflation persistence, suggesting that competition is not conducive to reducing persistence.

inflation dynamics, persistence, inflation targeting

Abstract:
The paper provides a simple theory and empirical evidence on the asymmetric effect of credit markets on output decline and output growth. When credit markets are underdeveloped and enterprise activity is financed outside the banking sector, exogenous shocks may induce a break-up of both credit and production chains, leading to sudden and sharp collapses in output. The development of a banking sector can reduce the probability of such collapses. Using industry-level data across a large cross-section of countries, the empirical analysis suggests that credit markets play a more important role in softening output declines than in fostering growth or recovery. These results suggest that credit markets are one of the main suspects for explaining why the magnitude of output declines tends to be larger in emerging markets than in advanced market economies.

credit and output, Emerging Economies, sharp recessions

Abstract:
The paper analyses the pressures on the pace of reform that can arise through fiscal constraints. A simple analytical framework is used to illustrate the relation between the budget deficit and the pace of restructuring, unemployment, and the relative dynamics of state and private firms. It is shown that fiscal pressures become stronger while the transition progresses. Demands on governments to slow down restructuring mount, as well as demands for compensating transfers to groups affected by reforms. Thus, governments face an important trade-off between fiscal targets and restructuring objectives. Together with pressures arising from increasing income inequality and lobbying from specific interest groups such as pensioners, fiscal constraints have probably played a major role in the reform cycle observed in many Central and East European countries. They have been particularly influential in determining the asymmetry between economic and political cycles. An example of the changing speed of reforms is the continuing delay to privatization. More generally, the widespread electoral successes of parties originating from former communist organizations testify to the pressure to change the pace of reforms.