Jan Frait

The Real Exchange Rate Misalignment in the Five Central European Countries — Single Equation Approach

Both policy makers and market participants have a strong interest in appropriate estimates of equilibrium real exchange rates and their prospective movements. They have also a keen interest in understanding determinants of the equilibrium real exchange rate and the factors behind implied misalignments of the actual rate from its equilibrium level. The real exchange rate is viewed as a key indicator of external competitiveness. Hence, a real appreciation of the exchange rate is often interpreted as a loss of price competitiveness. Nevertheless, this applies only if the real exchange rate becomes overvalued in relation to the equilibrium one. At the same time, real exchange rate appreciation can simply reflect improved competitiveness thanks to an increase in productivity. In this sense, the study of the determinants of the real exchange rates may shed some light on whether a real appreciation causes a loss in competitiveness or reflects the improvements in it (see also Frait and Komârek (1999, 2001)). The real exchange rate misalignments may be rather costly. Both overvalued and undervalued currencies have their negative implications. From policymakers’ perspective, the risks implied by the overvaluation are more important. There is an empirical support for the view that an overvalued currency leads to lower economic growth, especially via the impact on the manufacturing (see e.g. Razin and Collins, 1997).

Exchange Rate and Monetary Developments in Accession Countries

In the last two years there has been an unprecedented surge in discussions on the readiness and willingness of EU accession countries (ACC) to join EMU and introduce the euro. In 2002 most national central banks published their strategies towards the euro. They opted for rather early adoption of the euro after their countries became EU members. However, professionals in the field of economics have not reached consensus. There are also voices warning against the so-called fast-track approach. The focus of this chapter is primarily the validity of the arguments for and against early introduction of the euro in the ACC. After introducing a brief overview of discussions on the euro in Section 6.1, we will then define and compare various measures of nominal and real convergence (Section 6.2). Section 6.3 describes in detail the exchange rate developments in selected ACC with emphasis on real exchange rate trends. Section 6.4 will highlight some issues of inflation dynamics, convergence in price levels and implied challenges for monetary policy. Exchange rate regimes in the pre-accession period, the length of the period itself, as well as the relevance of the OCA theory will be discussed in Section 6.5. An overview of exchange rate strategies before the introduction of the euro will be presented in Section 6.6.

An Analysis of Inflation in the Czech Republic Using the P* Model

At the beginning of 1998, the Czech National Bank (CNB) switched from money supply targeting to direct inflation targeting. Implementation of this new monetary policy mechanism depends on the existence of reliable instruments for predicting inflationary pressures. The so-called P* inflation model, a relatively simple representation of the inflation dynamic, is one instrument that was regarded with great optimism in the early 1 990s. This model allows for the prediction of inflation as a shortrun process in which the real price level adjusts to the equilibrium price level determined according to the quantity theory of money. The aim of this article is to define a version of the P* model for the Czech Republic and to apply it to a time series from the period 1991 to 1998. The studys aim is also to show that inflation in the Czech Republic develops in accordance with standard theoretical principles and is primarily a monetary phenomenon. The organization of the remainder of this text is as follows. Part 1 contains a description of how the P* model

Costs of Macroeconomic Instability in Accession Countries

The aim of this chapter is to show the impact of macroeconomic and financial instabilities on the CEC in the last ten years whereby financial crises and swings in macroeconomic conditions were among the most important driving forces of changes in reform strategies. This chapter proceeds as follows. The first section will show some of the main revisions of the transition process. The next section will provide some generalizations and facts concerning the activities of the fundamental indicators among selected countries that are crucial for financial instability. Section 5.3 will analyse the effect of currency crises on investment and economic performance for CEC, as well as other selected ACC. And finally, the chapter will conclude with a summary of our findings as well as some issues to consider for future research.