Exchange rate regimes and exchange market pressure in the new EU Member States

Abstract:

Economic theory has stressed the vulnerability to currency crises of intermediate exchange regimes. ERM II constitutes a fixed but adjustable pegged exchange rate arrangement and can therefore be categorized as an intermediate regime, in contrast to polar regimes such as currency boards and freely floating exchange rates. Our regression results for eight new EU Member States reveal the role of economic fundamentals in explaining exchange market pressure in these countries and confirm the bipolar view on exchange rate regimes. We conclude that the new EU members should not enter ERM II before their fundamentals are strong enough to compensate for the vulnerability of the exchange rate regime. Otherwise the condition for entering EMU, i.e. preceding participation in ERM II without devaluation or serious tensions on the exchange market, could be jeopardized.

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