Fit for EMU? Comparing the new member states with Southern Europe

The relatively disappointing performance of the countries of Southern Europe in European Monetary Union (EMU) raises the question as to whether relatively unstable economies with a significant 'catching-up potential' (the potential for high growth) are desirable partners in a monetary union with more robust economies. This issue is extremely relevant for the new member states of Central and Eastern Europe (CEECs), now going through a painful adjustment process to qualify for EMU.

Economists and commentators have identified a potential risk - defined as a 'post- Maastricht hangover' - from the rapid nominal adjustment in preparation for EMU membership. This makes prospective members more vulnerable to boom-bust cycles, which may be aggravated by the loss of the monetary policy tool once in the currency union.

EMU membership is not the root cause of the alleged economic malaise in Southern Europe. There is no common economic problem as such; South European countries differ quite considerably with regard to growth trends and fiscal position. Moreover, boombust cycles here are overall modest in size and duration.

In contrast, adjustment problems following accession to EMU derive from failed reforms and the ensuing persistence of institutional rigidities.

Thus it is even less likely that the CEECs will be affected by the 'Maastricht hangover' when they join the monetary union. Returning to equilibrium should take less time than in the rest of the EU. In fact, compared to South European countries, CEECs benefit from much more efficient labour markets, which are either highly decentralized or highly centralized. Both conditions guarantee efficient wage responses to cyclical fluctuations. Moreover, recent structural reform has created such a stable high-growth environment that a 'soft landing' is more likely here than in, say, Spain or Portugal.

CEECs face only one major challenge: the strong pace of growth in the underdeveloped construction sector brings the risk of inflation, especially if coupled with a surge in credit. This risk should be bearable if the construction sector makes a significant contribution to economic growth. However, the evidence is not conclusive.