Euro convergence criteria

RAPS Euro Convergence Draws Participants From 32 Countries to Hear From European Regulatory Experts

Retrieved on: 
Wednesday, May 12, 2021
Articles, Information and communications technology, Technology, Eurozone, Euro convergence criteria, Technological convergence, Euro, Convergence of accounting standards

For more details on specific sessions and speakers, see Regulatory Focus news coverage of Euro Convergence 2021 .\n\xe2\x80\x9cI was quite impressed with this year\xe2\x80\x99s Euro Convergence.

Key Points: 
  • For more details on specific sessions and speakers, see Regulatory Focus news coverage of Euro Convergence 2021 .\n\xe2\x80\x9cI was quite impressed with this year\xe2\x80\x99s Euro Convergence.
  • It was extremely well organized and smoothly run,\xe2\x80\x9d said Rainer Voelksen, chair of the RAPS EU board.
  • \xe2\x80\x9cIt\xe2\x80\x99s even more impressive that this is only the second year RAPS has hosted Euro Convergence completely online.
  • Founded in 1976, RAPS helped establish the regulatory profession and continues to actively support the professional and lead the profession as a neutral, non-lobbying nonprofit organization.

2021 HICP weights and their implications for the measurement of inflation

Retrieved on: 
Friday, March 26, 2021
Price indices, Inflation, Macroeconomics, Economy, Money, Economy of the European Union, Harmonised Index of Consumer Prices, Eurozone, Euro convergence criteria

Households increased their relative expenditure share of certain categories in the HICP basket at the expense of others.

Key Points: 
  • Households increased their relative expenditure share of certain categories in the HICP basket at the expense of others.
  • This box discusses these changes in consumption and their implications for inflation measurement.
  • HICP weights for 2021 were updated using data that also reflect 2020 household consumption expenditure.
  • The large shifts in 2020 household consumption are thus now reflected in the latest HICP weights that were used to compute the 2021 HICP inflation rates.
  • [3] The latest annual HICP weights which were introduced at the beginning of 2021 show large shifts across categories.
  • Chart A shows the values of the HICP weights used for compiling inflation in 2020 and 2021 by special aggregates and their historical distribution over the 2012-19 period (the grey whiskers).
Chart A

    HICP weights: levels and historical changes distributions (percentage points)
    • Chart B shows the change in spending weight and the corresponding change in the inflation rate by granular spending categories.
    • [5] The size of the bubble reflects the 2021 HICP spending weight.
    • [6] Intuitively, with the change to 2021 weights, the HICP currently assigns more weight to categories with a higher-than-average inflation rate, while it assigns less weight to items with a lower-than-average inflation rate.
Chart B

    Changes in HICP weights and inflation by granular spending categories (x-axis: percentage change in HICP weights between 2020 and 2021; y-axis: change in annual inflation rates between January 2020 and January 2021)
    • A counterfactual exercise can quantify the upward impact of the change in weights on the January 2021 HICP inflation rate.
    • Based on the published HICP inflation rates for January 2021, we have constructed a counterfactual HICP index using the 2020 weights instead of those from 2021 (Chart C).
    • [7] The difference between the published HICP inflation rates (blue bars) and our counterfactual inflation rates (yellow bars) in the upper panel of Chart C reflects the impact of the new weights on aggregate inflation.
    • Nevertheless, as shown in the lower panel of Chart C, the effect across countries was heterogenous.
Chart C

    Published year-over-year HICP inflation rates and counterfactual inflation rates (percentages)
    • The magnitude and the sign of the weight impact on annual HICP inflation could change over the course of the subsequent months.
    • While in January 2021 the weights of categories with above-average inflation rates were increased, these categories might not continue to exhibit above-average inflation rates throughout the year.
    • As price developments in individual categories change from month to month, the weight effect on annual HICP inflation develops accordingly.
    • This could again lead to the energy index not fully returning to previous levels, even if both prices and weights return to their previous levels.

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

Retrieved on: 
Wednesday, January 6, 2021
Eurozone, European Union, Foreign exchange market, European Exchange Rate Mechanism, Enlargement of the eurozone, European Monetary System, Euro convergence criteria, Bulgarian lev, Banking union, Euro, ERM, Danish krone

Their inclusion marks a milestone towards future enlargement of the euro area, given the important role that ERM II plays as a preparatory phase for euro adoption.

Key Points: 
  • Their inclusion marks a milestone towards future enlargement of the euro area, given the important role that ERM II plays as a preparatory phase for euro adoption.
  • Participation in ERM II may lead to a regime shift in the country concerned, i.e.
  • We provide evidence that a regime shift indeed occurred in the central and eastern European countries (CEECs) that joined the mechanism in 2004 and 2005.
  • If supported by sound economic policies, this shift may have positive consequences, such as accelerating the convergence process.

1 Introduction

    • The inclusion of the Bulgarian lev and the Croatian kuna in ERM II is a milestone towards further enlargement of the euro area.
    • [3] For Bulgaria and Croatia, ERM II will therefore serve not only as an exchange rate arrangement, but also as a preparatory phase for euro adoption.
    • Specifically, Section 2 briefly reviews the history, main features and procedures of ERM II.
    • Section 3 argues on the basis of quantitative evidence that ERM II may lead to a regime shift in participating countries on the path to euro adoption.
    • Section 4 explains the roadmap towards ERM II participation that was established and implemented for Bulgaria and Croatia.
    • Finally, Section 5 concludes by highlighting the way ahead and the key challenges faced by Bulgaria and Croatia on the path towards euro adoption.

2 The history, main features and procedures of ERM II

    2.1 History

      • [5] The original ERM, a core element of the EMS, was aimed at reducing exchange rate variability and fostering monetary stability among the currencies of an initial eight Member States.
      • With the introduction of the euro, the Danish krone and the Greek drachma were included in the new mechanism, ERM II.
      • Chart 1 Exchange rate regimes of EU Member States since the start of the European Monetary System
      • On 1 May 2004 ten new Member States joined the European Union and their national central banks (NCBs) became part of the ERM II Central Bank Agreement.
      • On 28 June 2004, soon after EU enlargement, the Estonian kroon, the Lithuanian litas and the Slovenian tolar were added to ERM II.
      • On 2 May 2005 the Cyprus pound, the Latvian lats and the Maltese lira joined the mechanism, followed by the Slovak koruna on 28 November 2005.

    2.2 Main features

      • ERM II was established by the European Council Resolution of 16 June 1997[6], which stipulated that The euro will be the centre of the new mechanism.
      • The main features of ERM II are (i) a central rate against the euro, (ii) a fluctuation band with a standard width of 15% around the central rate, (iii) interventions at the margins of the agreed fluctuation band, and (iv) the availability of very short-term financing from the participating central banks.
      • During ERM II participation, realignments of the central rate or adjustments to the width of the fluctuation band may occur, for example if equilibrium exchange rates change over time.

    2.3 Main procedures

      • While ERM II is referred to in the Treaty as an integral part of the Maastricht exchange rate convergence criteria, the ERM II procedures and agreements are not based on the Treaty, since they are intergovernmental in nature.
      • The decisions are taken at the end of a process involving consultation of the EWG.
      • The European Commission is also involved in this process; it participates in the relevant meetings, can be mandated particular tasks and is kept informed by the ERM II parties.
      • all non-euro area Member States except Denmark, are expected to join the mechanism at some stage.
      • All parties take part in the search for consensus in a positive spirit, and negotiations continue until there is an agreement acceptable to all.

    3 The “regime shift” effect of ERM II on investor and policymaker behaviour

      3.1 Motivation

        • The full benefits of euro adoption can only be enjoyed if adequate policy measures are in place, including at the national level.
        • [9] Attaining a high degree of sustainable convergence (Article 140 of the TFEU) is the most important precondition for the successful adoption of the euro.
        • To this end, sound policies and an adequate level of institutional quality are of the essence.
        • They are therefore given due consideration when assessing the readiness of a non-euro area EU Member State to participate in ERM II.
        • The analysis focuses on the CEECs that joined ERM II in 2004 and 2005 and subsequently adopted the euro: Estonia, Latvia, Lithuania, Slovenia and Slovakia.

      3.2 Evidence

        • Gross financial inflows as a share of GDP accelerated ahead of EU accession, which for some countries also coincided with the start of their participation in ERM II.
        • [11] However, countries that joined ERM II experienced a much stronger surge (see Charts 2 and 3).
        • Gross financial inflows in ERM II countries peaked about three years after they joined ERM II, at an average of around 30% of GDP (see Chart 2).
        • [12] Supporting the quantitative evidence, internal econometric analysis on a sample of emerging market and (former) transition economies shows that the degree of flexibility of the exchange rate regime does not affect financial inflows to these countries, whereas ERM II participation is found to increase the magnitude of gross financial inflows.


        Chart 3 Gross international financial inflows of CEECs not participating in ERM II before and after joining the European Union (as a percentage share of GDP; unweighted averages)

        • The largest share of financial flows to ERM II CEECs took the form of other investment, consisting mainly of bank lending to firms and households and flows within banking groups.
        • While this may reflect the strong presence of foreign (mostly EU-based) banks in ERM II CEECs during that period, it was a common feature across the whole region.
        • At the same time, ERM II countries experienced negative average short-term real interest rates in the three to four-year period after joining ERM II.
        • In addition, the drop in long-term real interest rates was much stronger in ERM II countries than in non-ERM II countries (see Chart 5).
        • Chart 4 Domestic credit to the private sector in ERM II and non-ERM II CEECs (as a percentage share of GDP; unweighted averages)


        Chart 5 Real interest rates in ERM II and non-ERM II CEECs (percentages)

      3.3 Policy implications

        • ERM II participants may benefit from increased availability of capital, but they may also face an increased risk of a build-up of macroeconomic imbalances.
        • Resilient economic structures create the preconditions for allocating capital to productive firms, thus supporting the catching-up process rather than the formation of bubbles.
        • However, if institutions are weak, such financial inflows are more likely to eventually become a disadvantage more than a benefit.
        • The smooth participation of a given currency in ERM II therefore requires the proper framework conditions to be in place at the national level.
        • If these improvements do not take place, excessive ease of financing after joining ERM II and later after adopting the euro risks reducing the incentives to make necessary reforms.

      4 The Bulgarian lev and the Croatian kuna in ERM II

        • In the summers of 2018 and 2019 respectively, following discussions with the ERM II parties, the Bulgarian and Croatian authorities made a number of policy commitments in areas of high relevance for a smooth transition process and subsequent participation in ERM II.
        • After fulfilment of these so-called prior policy commitments, as well as the announcement of post-entry policy commitments to be completed after joining ERM II, the two countries entered ERM II and European banking union simultaneously on 10 July 2020.
        • This section explains the rationale for ERM II participation and the roadmap towards it that was implemented for these two EU Member States.
        • When Bulgaria and Croatia first expressed their interest in joining the mechanism, ERM II parties took account of three fundamental considerations.
        • First, it would be the first time a country had joined ERM II since the financial crisis, from which important lessons had been learned.
        • In particular, the experiences of former ERM II participants had confirmed that these features needed to be in place to ensure smooth participation in the mechanism.
        • Second, it would also be the first time a Member State had joined ERM II since the start of Europeanbanking union.
        • Given that ERM II is a preparatory phase for euro adoption, joining ERM II today also means preparing for banking union.
        • During the informal phase of the roadmap towards ERM II participation, a dialogue was held between the ERM II parties and the Bulgarian and Croatian authorities on the risks that had been identified and how they could be mitigated.
        • Once this phase was completed, the last step in the roadmap was marked by the formal requests for the inclusion of the Bulgarian lev and the Croatian kuna in ERM II, which were sent the day before the decision was taken.
        • those in the banking supervision and macroprudential fields), which were completed by the time the two countries joined ERM II.
        • After the completion of their prior commitments, Bulgaria and Croatia joined ERM II and banking union.
        • Box 2 Completion of ERM II prior policy commitments related to structural policies In their letters to the exchange rate mechanism (ERM II) parties, Bulgaria[31] and Croatia[32] committed themselves to implementing a number of policy measures related to structural policies before joining ERM II.
        • The European Commission was mandated by the ERM II parties to monitor the implementation of these prior policy commitments, in line with its remit.
        • The monitoring was facilitated by regular technical exchanges between the Commission and the Bulgarian and Croatian authorities.
        • The European Commission provided regular progress updates to the ERM II parties.

      Post-entry commitments made by Bulgaria and Croatia on joining ERM II

        • The central rate of the Croatian kuna against the euro within ERM II was set at the prevailing market rate at the time of its inclusion.
        • In line with past practice, the central rate was equal to the official ECB reference rate published daily on the ECBs website of the Friday prior to the currencys inclusion in ERM II.
        • The inclusion of the Croatian kuna in ERM II is also subject to the standard fluctuation margins of 15%.
        • Box 3 Assessing the central rates of the Bulgarian lev and the Croatian kuna within ERM II Bulgaria and Croatia have both maintained nominal exchange rate stability for more than two decades (see Chart A).
        • Chart A Exchange rates of the Bulgarian lev and the Croatian kuna against the euro (4 January 1999 to 14 October 2020; national currency units per euro)
        • Thus, the issuance of Bulgarian levs is not discretionary, but directly linked to the availability of international reserves.
        • As a result, BNB does not need to undertake traditional foreign exchange interventions in order to maintain the exchange rate peg.
        • Instead, it issues or absorbs national currency solely against reserve currency in transactions with the banking sector, referred to as type II interventions, such that the national currency supply automatically equates to the demand.
        • As a result of their credible commitments to maintaining exchange rate stability, both national central banks have accumulated comfortable buffers of foreign exchange reserves.
        • Since the global financial crisis of 2007-08, BNB and HNB have significantly expanded their holdings of foreign exchange reserves.
        • In the case of the Bulgarian lev, this was equal to its fixed exchange rate under the currency board arrangement.
        • Thus, the Bulgarian lev was included with its central rate set as its fixed exchange rate of 1.95583 levs per euro.

      5 Conclusion: the way ahead and related challenges

      Consumption patterns and inflation measurement issues during the COVID-19 pandemic

      Retrieved on: 
      Wednesday, November 11, 2020
      Price indices, Macroeconomics, Economy, Harmonised Index of Consumer Prices, Consumer price index, Monetary economics, Inflation, Euro convergence criteria

      The pandemic has generated two main challenges when measuring consumer price inflation.

      Key Points: 
      • The pandemic has generated two main challenges when measuring consumer price inflation.
      • First, the pandemic triggered unusually large changes in household spending patterns which are not reflected in aggregated consumer price indices.
      • [3] The HICP is compiled using consumption weights that are kept constant within a given calendar year.
      • When constructing the HICP, the price changes of individual items are weighted using household consumption shares that are fixed for the calendar year.
      • This reflects the intended purpose of the HICP of estimating pure price changes without accounting for shifts in household consumption patterns.
      • While keeping the weights constant within a calendar year does not generate measurement issues in normal times, the nature of the pandemic shock has triggered large consumption shifts over a short period of time.
      • There is a growing body of literature documenting large pandemic-induced changes in household consumption and discussing their implications for inflation.
      • The available data suggest that household consumption patterns have changed significantly during the pandemic.
      • Relative consumption patterns were stable until the beginning of the pandemic (see Chart A), but the pandemic and the lockdown measures led to a large increase in the weight of some categories (such as food items and communication services) and a reduction in other categories (such as recreation and energy goods).
      • As Chart A reports relative weights, some categories show an increase in March/April because the nominal spending in that category contracted less than overall consumption.
      • Table A shows our estimates of the development of nominal household spending across categories.
      • Since the beginning of the pandemic, inflation as measured by our experimental index has been running higher than HICP inflation, and the difference has remained broadly stable in recent months.
      • Chart B shows the gap between the annual rates of change (year-on-year) of the experimental index and the HICP (the orange line in panel a).
      • This gap started to open up in March (as shown by the orange bars in panel b) and increased to about 0.2 percentage points in April.
      • [14] Intuitively, this reflects consumers switching from lower-than-average inflation categories (such as fuel for transport, covered by Energy) to higher-than-average inflation categories (such as food items).
      • The lockdown period also caused issues for HICP price collection.
      • [15] Price collection in bricks-and-mortar stores stopped where outlets were closed.
      • In addition, sampling in supermarkets and drugstores was largely discontinued in order to protect price collectors.
      • Chart C shows the evolution of price imputation in HICP categories from March to August.

      The role of indirect taxes in euro area inflation and its outlook

      Retrieved on: 
      Friday, September 25, 2020
      Price indices, Economy, Macroeconomics, Economy of the European Union, Harmonised Index of Consumer Prices, Tax, Currency, Value-added tax, Euro, Inflation, Monetary Union Index of Consumer Prices, Euro convergence criteria

      Changes in indirect tax rates can have a visible impact on consumer prices.

      Key Points: 
      • Changes in indirect tax rates can have a visible impact on consumer prices.
      • This assumes the full and immediate pass-through of changes in indirect taxes to consumer prices and therefore, on balance, tends to overstate the effects of tax changes.
      • [1] Based on this measure, the contribution from changes in indirect taxes to euro area HICP inflation has been, on average, 0.2 percentage points, but was much stronger during periods when tax rates increased, such as in 2007 and between 2011 and 2014 (see Chart A).
      • Chart A HICP and HICP at constant tax rates (annual percentage changes; percentage point contributions)
      • However, in response to the coronavirus (COVID-19) pandemic, several euro area countries have reduced indirect tax rates on a scale not seen before in the euro area.
      • In addition to temporary reductions in broad-based value added taxes (VAT) in Germany and Ireland, many other euro area countries have recently introduced targeted reductions in indirect taxes (see Chart B).
      • [2] Assuming full and immediate pass-through, Eurostats HICP at constant tax rates implies that the reduction in VAT in Germany would have a downward impact on euro area HICP inflation in July 2020 of around 0.6 percentage points.
      • [3] Chart B Impact of changes in indirect taxes on HICP inflation (percentage point contributions based on difference between HICP and HICP at constant tax rates)
      • The actual impact of the recent reductions in indirect taxes on inflation is surrounded by considerable uncertainty.
      • First, historically there are few examples of cuts in indirect tax rates in euro area countries that could shed light on the likely degree of pass-through.
      • Lastly, the lions share of the current reduction in indirect taxes results from the VAT rate cut in Germany, which is only temporary (and very rare in euro area countries), and might thus generate unusual anticipation effects.
      • [6],[7] The pass-through of recent reductions in indirect taxes is likely to vary across sectors and to be overall incomplete.
      • The reductions in indirect tax rates in euro area countries shape the inflation profile for 2020 and 2021 in the September 2020 ECB staff projections.
      • Understanding the impact of indirect taxes on the inflation profile and outlook is relevant for the communication of monetary policy.
      • Chart C Impact of changes in indirect taxes on HICPX inflation projections (annual percentage changes; percentage point contributions)

      ECB reports on progress towards euro adoption for EU countries

      Retrieved on: 
      Thursday, June 11, 2020
      European Union, Eurozone, Economy of Europe, Economy of the European Union, Europe, Enlargement of the eurozone, European Central Bank, Euro, Euro convergence criteria, Romania and the euro

      PRESS RELEASE

      Key Points: 
      • PRESS RELEASE

        ECB reports on progress towards euro adoption for EU countries

        10 June 2020

        Mixed progress has been made by non-euro area EU countries on economic convergence with the euro area since 2018, with important steps taken to address fiscal imbalances, the June 2020 Convergence Report of the European Central Bank (ECB) concludes.

      • The report, issued every two years, assesses the progress towards euro adoption of currently seven EU countries that have not adopted the euro.
      • As regards the price stability criterion, compliance of the countries under review has worsened compared with the situation described in the previous Convergence Report.
      • In none of the countries examined is the legal framework yet fully compatible with all the requirements for adoption of the euro.

      ECB reports on progress towards euro adoption for EU countries

      Retrieved on: 
      Wednesday, June 10, 2020
      European Union, Eurozone, Economy of Europe, Economy of the European Union, Europe, Enlargement of the eurozone, European Central Bank, Euro, Euro convergence criteria, Romania and the euro

      PRESS RELEASE

      Key Points: 
      • PRESS RELEASE

        ECB reports on progress towards euro adoption for EU countries

        10 June 2020

        Mixed progress has been made by non-euro area EU countries on economic convergence with the euro area since 2018, with important steps taken to address fiscal imbalances, the June 2020 Convergence Report of the European Central Bank (ECB) concludes.

      • The report, issued every two years, assesses the progress towards euro adoption of currently seven EU countries that have not adopted the euro.
      • As regards the price stability criterion, compliance of the countries under review has worsened compared with the situation described in the previous Convergence Report.
      • In none of the countries examined is the legal framework yet fully compatible with all the requirements for adoption of the euro.

      International Inflation: Key Economic Indicators

      Retrieved on: 
      Wednesday, January 15, 2020
      European Union, Eurozone, Economy of the European Union, Europe, Multi-speed Europe, Euro, Inflation, Euro convergence criteria, Economy of Portugal

      EU inflation was 1.3% in November 2019, up from 1.1% in October.

      Key Points: 
      • EU inflation was 1.3% in November 2019, up from 1.1% in October.
      • EU inflation was 2.0% in November 2018.
      • Inflation in the Eurozone is provisionally estimated as 1.3% in December, up from 1.0% in November.
      • The lowest inflation rate in the EU was in Italy and Portugal (both 0.2%).

      A new method for the package holiday price index in Germany and its impact on HICP inflation rates

      Retrieved on: 
      Friday, March 22, 2019
      Economy, Economy of the European Union, Macroeconomics, Price indices, European Union, Inflation, Eurozone, Harmonised Index of Consumer Prices, Euro, Price index, Index, Euro convergence criteria

      A new method for the package holiday price index in Germany and its impact on HICP inflation rates

      Key Points: 
      • A new method for the package holiday price index in Germany and its impact on HICP inflation rates

        Published as part of theECB Economic Bulletin, Issue 2/2019.

      • One such improvement is a change in the way the price index for package holidays is calculated in the HICP for Germany, which was implemented with the HICP release for January 2019.
      • The German price index for package holidays now shows a more meaningful seasonal pattern.
      • The methodological change has led to a more pronounced seasonal profile for the package holiday price index for Germany and also for the euro area.

      The mechanical impact of changes in oil price assumptions on projections for euro area HICP energy inflation

      Retrieved on: 
      Friday, February 8, 2019
      Economy, Economy of the European Union, Macroeconomics, Inflation, Price indices, Eurozone, Harmonised Index of Consumer Prices, Price of oil, Euro, Euro convergence criteria

      The mechanical impact of changes in oil price assumptions on projections for euro area HICP energy inflation

      Key Points: 
      • The mechanical impact of changes in oil price assumptions on projections for euro area HICP energy inflation

        Published as part of theECB Economic Bulletin, Issue 1/2019.

      • Using the oil price futures has an important bearing on the projections for HICP energy inflation.
      • This box documents the mechanical implications of a shift in the oil price assumptions for the projections of the energy component of HICP inflation.
      • The implications of the recent oil price developments are a reminder of the uncertainty regarding energy inflation projections.