Strategic Exchange-Rate Policy of Accession Countries in ERM II

Christian Fahrholz

Eastward Enlargement of the Euro-zone Working Papers from Free University Berlin, Jean Monnet Centre of Excellence

Abstract: Exchange-rate policies of Central Eastern European Countries (CEEC) have often been a subject matter. Yet, some new insights in terms of political economy considerations upon exchange-rate policy are provided. It is pointed out that it is more appropriate to analyse exchange-rate policy in course of Exchange Rate Mechanism II (ERM II) with regard to a changing incentive structure. In doing so, considerable moral hazard problems become apparent. ERM II shall provide for an adequate level of convergence between prospective and current members of European Monetary Union (EMU). However, this institutional arrangement and, particularly, its impact on the incentives for exchange-rate policy making might enable CEEC to load considerable costs of convergence onto current members. Accordingly, the phase of ERM II is considered to be a bargaining on the distribution of costs of convergence between prospective and current members of EMU. In return, accession countries would offer to maintain public support for European integration. The CEEC’ leverage in this bargaining rests on brinkmanship, i.e. putting exchange-rate regimes at risk, thus possibly undermining the according public support. This paper delineates the basic assumptions and conditions for successful brinkmanship, points out the specific transmission mechanisms, and characterises this kind of exchange-rate policy as ‘threaten-thy-neighbour’. Overall analysis results in a cautious outlook on probable effects of such strategic exchange-rate policies on European institutional and economic matters.

Keywords: brinkmanship; exchange-rate policy (search for similar items in EconPapers)
Pages: 29 pages
Date: 2003-04-01, Revised 2003-04-01
New Economics Papers: this item is included in nep-eec, nep-ifn and nep-tra
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Citations: View citations in EconPapers (2)

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