DP4500 Hansa vs Habsburg: Debt, Deficits and the Entry of Accession Countries into the Euro

Author(s): Andrew Hughes Hallett , John Lewis

Publication Date: July 2004

Keyword(s): convergence , monetary union , subsidarity , fiscal policy , debt

JEL(s): E62 , H63 , P27

Programme Areas: Institutions and Economic Performance , International Macroeconomics , Transition Economics

Link to this Page: www.cepr.org/pubs/dps/DP4500.asp

Price and output level convergence between new member states and the existing EU necessarily implies inflation and growth divergence for many years to come. That complicates the conditions for accession to the euro. In this Paper, we focus on debt dynamics for the eight new member states from Central and Eastern Europe. We find that the nominal Maastricht criteria are at best irrelevant, and at worst damaging for the duration of the catch-up process and well past any plausible test date for euro area entry. There are strong indirect effects of nominal criteria, however, which make it harder to achieve the fiscal criteria. Our results suggest all countries would find it harder to restrain debt growth within the euro, but that the magnitude of this effect varies substantially across countries, as do the debt dynamics outside the euro. If nominal criteria are suspended, the policy instruments required to achieve euro convergence are in the hands of the individual states and are affected by external policies only to the extent that there are growth, inflation or monetary spillovers from the euro area. This suggests that the principle of subsidiarity could be applied to euro membership, placing decisions over entry in the hands of individual member states.