Title: Is economic convergence in New Member States sufficient for an adoption of the Euro?
Abstract: 1. Introduction Ten countries have joined the European Union (EU) on May 1st, 2004: Poland, the Czech Republic, Slovakia, Hungary, Slovenia, Estonia, Latvia, Lithuania, Cyprus and Malta. Bulgaria and Romania also joined the EU in January 2007. These New Member States (NMS) are expected to enter the Third Phase of the European Monetary Union (EMU), thus adopting the euro, as soon as they fulfil the Maastricht criteria, that is to say when their economy has reached a level of convergence which makes it possible for them to abandon the monetary instrument. At the same time, by trying to fulfil the fiscal criteria, they also decide to give up part of the fiscal instrument; indeed, after adoption of the European single currency, the use of fiscal policy will still be constrained by the Growth and Stability Pact; besides, the applicants are invited to join the Exchange Rate Mechanism (ERM2) of the European Monetary System (EMS), during at least two years without any devaluation, when they are ready to do so. Moreover, real convergence is necessary: the NMS' economies should have converged towards the Euro(pean) business cycle; but we first need to assess the existence of a business cycle which would be specific to the euro area. According to the Optimal Currency Area (OCA) theory, which was first designed by Mundell (1961), Mac Kinnon (1963) and Kenen (1969), these countries are more suited to belong to a monetary union in so far as they fulfil criteria such as a high degree of external openness, mobility of factors of production, and diversification of production structures. In this paper, we shall see where the 2004-NMS that have not adopted the euro yet stand in terms of meeting or not the Maastricht criteria; then we will try to find out whether these NMS fulfil the criteria which have been identified by the OCA theory and which are more linked to the real convergence of an economy. The OCA theory is thus used to assess the macroeconomic costs associated with a participation of the new European countries in the European Monetary Union. Then, after having gone through a survey of the literature devoted to business cycles synchronisation, we will seek to determine if there is a clear correlation between those countries' business cycles and the European cycle, which would stand in favour of an early adoption of the euro in these countries. Further questions appear such as: among the new European members, have the ones that have already joined the ERM2 converged more quickly? Slovenia joined the euro area in January 2007, so did Cyprus and Malta one year later, because they fulfilled all the Maastricht criteria except for the public debt (which has decreased steadily in both countries, and is now below or close to the reference value of 60%); but, for other countries that have joined ERM2, is the non-fulfilment of a single criterion sufficient to postpone the accession to the euro area, as it was the case for Lithuania and Estonia? Given that, for old member states, the achievement of some criteria had been interpreted as a tendency, this would tend to indicate that the European institutions do not wish to let the new comers join the euro area too quickly. All these questions are in fact related to the problem linked to nominal and real economic convergence in the NMS: has the latter sufficiently increased lately for an early adoption of the euro in those countries? We shall see that two groups of countries emerge, according to the OCA theory: one group which is ready to join the club, and the other one which includes countries for which it is not yet the best solution. 2. The NMS and the Maastricht criteria: has nominal convergence been achieved? Central and Eastern European Countries (CEECs) have chosen a rather rigid currency policy at the beginning of the transition period in order to fight inflation, but they have gradually privileged a more flexible exchange rate system, because of a worsening of their current accounts (due to the appreciation of their real exchange rate) (1). …