Towards the EMU: A Need For Exchange Rate Flexibility?

Abstract: We address the question of exchange rate regime for the Czech Republic before it enters the EU and the EMU. We classify macroeconomic impacts of a single currency regime according to the traditional OCA theory. Using quantitative measures,we find the degree of macroeconomic convergence between the Czech and German (EU) economies high enough not to form a major obstacle to a common currency regime. In addition, we look at transitional specificities of the Czech economy. We analyse thereal appreciation of the Czech currency and its relationship to competitiveness and find that development of cost factors exercise depreciationary pressures on the exchange rate. Conversely, a fixed regime may alleviate problems of the foreign capital influx and ensuing nominal appreciation - another idiosyncrasy of the Czech economy. However, once labour market rigidities are removed, a fixed regime may become a source of a sustainable competitive advantage, growth, and convergence.