Ifo Viewpoint No. 10: Currency Boards for the New EU Member States

Hans-Werner Sinn
Munich, 23 Dec. 1999

By the year 2004, the first five Eastern European countries are expected to be granted EU membership. It is clear that they will not be given the euro at the point of accession, but how they will be linked to the euro zone is still unclear. An EMS III is under discussion in which exchange rate target zones will be agreed with the European Central Bank. But such a system will not effectively protect the national currencies from speculative attacks, as the 1992 West European currency crisis demonstrated, and the system will thus be accompanied by large risk premia in the national interest rates which will constrain the urgently needed influx of capital. The situation of the smaller Western European countries in the 1990s clearly shows where the problems lay. It was not until the fixed exchange rate system of the euro that the risk premia disappeared and that the risk-free movement of capital became possible.

Currency boards are appealing alternatives in light of this experience. Currency boards would mean that the new EU member states would have to buy euros to back their own monetary bases and have these euros at their disposal to ward off any attacks on their own currencies. The exchange rate to the euro would be prescribed by law, and the national central bank would be obligated to change the national currency into euros at this rate at any time. In contrast to a mere agreement on target zones, currency boards would produce credible, fixed exchange rates and thus create the low interest rates which would allow an unconstrained export of capital to the acceding countries. If currency boards are introduced at the time of accession, a rapid convergence of the economies of the Eastern European countries to the Western level can be expected, and thereafter they can be given the euro as their own currency.

Hans-Werner Sinn
President of the Ifo Institute