The European exchange rate mechanism (ERM II) as a preparatory phase on the path towards euro adoption – the cases of Bulgaria and Croatia

Ettore Dorrucci, Michael Fidora, Christine Gartner and Tina Zumer

Economic Bulletin Articles, 2021, vol. 8

Abstract: The Bulgarian lev and the Croatian kuna were included in the exchange rate mechanism (ERM II) on 10 July 2020. This marks a milestone towards further enlargement of the euro area. The process unfolded along a roadmap agreed by the various ERM II parties, which reflects the lessons learned from the past and the creation of banking union, as well as a careful assessment of country-specific strengths and vulnerabilities. First, this article briefly reviews the history, main features and procedures of ERM II. It then argues on the basis of quantitative evidence that the process of euro adoption may induce a regime shift when a country joins ERM II. This shift may alter the economic incentives of both domestic and foreign investors and the authorities of the Member State concerned, with important policy implications. For this reason, countries need sound policies, governance and institutions in order to allocate international financial inflows and domestic credit efficiently. They must also address risks with adequate macroeconomic, macroprudential, supervisory and structural measures. Drawing on this analysis, the third part of the article explains the rationale for ERM II participation and the roadmap towards it that has been successfully implemented for Bulgaria and Croatia. This includes the completion of several policy measures before joining ERM II, as well as post-entry policy commitments made by the Bulgarian and Croatian authorities. The article concludes by highlighting the way ahead and challenges faced by the two countries on the path towards euro adoption. JEL Classification: E42, F02, F31, F33, F45

Keywords: ERM II; euro adoption; Exchange rate mechanism (search for similar items in EconPapers)
Date: 2021-01
Note: 339035
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