David Begg (Birkbeck College, London, and CEPR) opened the workshop with a paper on ‘Exchange Rate Regimes in Central and Eastern Europe: Lessons from Transition 1990–96’. He subdivided the transition into two stages. The first stage or ‘stabilization period’ requires strong macroeconomic management and a fixed exchange rate to play the important role of a nominal anchor, but the second stage is more complex. Begg stressed the importance of structural microeconomic adjustment in the second stage, but his primary focus was on exchange rate regimes and capital inflows.

Begg suggested that foreign investors’ expectations of future growth in the Czech Republic were exaggerated, leading to excessive capital inflows in 1995 and 1996. The events of the spring of 1997 were therefore a natural adjustment to correct the fast-growing borrowing of Czech subjects. The initial reaction of the Czech government to high capital inflows should have been a tighter fiscal policy in order to keep aggregate demand under control. But since fiscal policy is known to be an extremely crude and slow policy tool, an adjustment of the capital markets was unavoidable. Jan Klacek (Economics Institute of the Czech National Bank) stressed the role played by total public sector expenditures, noting that the municipalities' budgets had gone from surplus to a substantial deficit in only three years.

Vladimír Dlouhy (Czech Economic Research Association and former Minister of Industry and Trade) presented a paper on 'Trade Balance and Exchange Rate Relationships in the Czech Republic'. The paper provided an overview of the government's macroeconomic policy since 1992 and stressed the impact of the lax fiscal policy. Analysing monetary tightening by the Czech National Bank (CZB) in 1996, Dlouhy maintained that it had caused a slump in aggregate supply but, by failing to reduce aggregate demand, it had contributed to the growing macroeconomic imbalance and, hence, to the crisis in 1997. Oldøich Dìdek (Czech National Bank) pointed to the political business cycle, which had led to the relaxation of fiscal policy in 1996, and – given that the Czech crown was appreciating in 1996 – questioned whether the CNB had had another option as far as the exchange rate regime was concerned. Miroslav Singer (CERGE-EI, Expandia Finance and CEPR) believed that an earlier switch to a floating regime would have prevented the large-scale capital outflow in May and June 1997. For Andrew Burns (OECD), the cause of the ballooning current account deficit had been a too rapid growth of wages. In the absence of microeconomic restructuring, moreover, this problem remained an imminent threat to the Czech economy.

Charles Wyplosz (Graduate Institute of International Studies, Geneva, and CEPR) presented a paper, entitled 'Contagious Currency Crises', in which he argued that increasing capital mobility makes currency fluctuations more volatile and contagious. Using an extensive data set for 20 countries over a 24-year period, he showed that that there was a growing tendency towards contagion in currency crises, and that it was relaxed monetary, rather than fiscal, stances that led to such crises. Ludìk Niedermayer (Czech National Bank) acknowledged the relevance of contagion in exchange rate crises, but questioned the validity of using historic data for future policy recommendations. Pegging their exchange rates to the currency of their main trading partners may, according to Niedermayer, offer a second-best solution for transition countries.

Richard Portes (London Business School and CEPR) presented 'Coping with International Capital Flows', which he had co-authored with David Vines (Balliol College, Oxford and CEPR). Portes raised the issue of the switch of the exchange-rate regime from fixed- to floating-rate and explained that the (optimal) timing of the switch depended crucially on the nature of the capital inflows. If these were perceived by both investors and authorities as permanent, the floating-rate regime would remain sustainable. In the Czech case, a substantial part of the inflows was long term so the optimal policy was to accommodate the inflows and let the currency float. Portes questioned whether a fiscal tightening in 1996 would have been possible (and desirable), since the deficit on the consolidated government budget had been only negligible. Tightening, according to Portes, would have restricted the growth of the economy and contributed to the currency appreciation.

Miroslav Singer (CERGE-EI, Expandia Finance and CEPR) pointed out that the banking sector had required substantial bailouts by the CNB in 1996 and that this had generated a 'quasi-fiscal' expansion. Mark Allen (IMF Budapest) reiterated the Fund's view that Czech wage growth had been too high and had led to excessive aggregate demand. Both Andrew Burns and Judit Neményi (National Bank of Hungary) emphasized the importance of the role of bad loans in any assessment of overall economic stability, and questioned whether the Czech banks could have performed better given such high ratios of non-performing loans.

David Begg suggested that the discussion of the causes of the Czech currency crisis seemed to point to four general hypotheses: a) general nervousness among foreign investors, who had panicked without obvious reason; b) worsening fundamentals, causing a capital outflow; c) overheating due to a hidden fiscal expansion caused, in turn, by the bad bank-loans problem; and d) rising inflation, which was caused by high capital inflows and which undermined Czech competitiveness. Vladimír Dlouhy and Ondrej Schneider (Charles University and Ministry of Industry and Trade, Czech Republic) expressed the view that the slowdown in growth, without accompanying stabilization of the external account, had resulted from an asymmetric reaction by the Czech economy to the monetary tightening.

In ‘The Stability of the French Franc: Sound Economic Fundamentals and Credibility’, Jean Cordier (Banque de France) described the development of French monetary policy from the repeated crises and devaluations of the 1970s and 1980s to the relative stability of the 1990s. He emphasised the crucial importance of a pegged exchange rate mechanism for European integration. Charles Wyplosz was curious about whether the underlying thesis of Cordier’s paper implied that a stable exchange rate is a trade policy measure. He pointed out that transition countries can expect a faster productivity growth and can therefore afford inflation rates somewhat above the rates prevailing in the EU.

István Székely (National Bank of Hungary and Budapest University of Economics) presented a paper on ‘The Relationship Between Monetary Policy and Exchange Rate Policy in Associated Countries: Is There Room for Independent Monetary Policy on the Way to EU Membership?’. He classified different exchange rate policy regimes and stressed the difficulty of timing regime changes. For this and other reasons, he argued, a desirable exchange rate regime should be flexible enough to accommodate rapid changes in the government’s economic policies.

Analysing the prospects of associated countries joining the EU, Székely stressed the necessity of stabilizing exchange rates beforehand, which in turn requires a sound and properly regulated banking sector together with fiscal prudence. He concluded that whatever exchange rate regime is chosen, it can be sustained only if the government and central bank have clearly stated preferences and are able to rank them in order to implement a consistent mix of policies. Ondrej Schneider (Charles University, Prague) emphasised the political costs of changing the exchange rate regime and pointed to a lack of coordination between the Czech government and the central bank in 1996 and 1997. Neither the government nor the central bank were able to give explicit targets for their respective policies, and the privatization process slowed down significantly in 1996.

Rutger Wissels (European Commission) noted that the end-goal of the transition countries was EU membership; consequently, their policies should be adjusted to this objective.