According to recent European Union (EU) decisions at summits in Brussels and Copenhagen, EU enlargement is scheduled for 1 May 2004. Ten countries Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia are invited to enter the European Union.
A question of sharing a common monetary policy will then emerge. By looking at the degree of synchronization of business cycles, which is one of several optimal currency area (OCA) criteria, we assess if it would be beneficial for candidate countries to join the European Monetary Union (EMU) immediately upon entering the EU, or postponing for a number of years. More specifically, the paper has the following two main objectives.
The first objective is to estimate whether aggregate demand and supply shocks between EU and candidate countries are becoming more symmetric as enlargement negotiations proceed. According to the OCA theory, higher symmetry of shocks between countries, inter alia, leads to lower cost of sharing a common monetary policy. As far as the EU candidate countries are concerned, empirical studies have only recently begun to appear, when longer time series are becoming available. The still scarce evidence suggests that selected Central and Eastern European countries (CEECs) have achieved some synchronization of their business cycles with the EU, at least on the demand side. It is commonly stressed, however, that the period of transition is too short to draw robust conclusions. For this reason, we use several alternative approaches to estimate the degree of shock asymmetry in the CEECs.
The second, and the main objective of the paper, is to analyze factors that affect the synchronization of shocks. As argued in the literature, OCA criteria fulfillment may be endogenous, i.e. that they are likely to be more satisfied ex post, as both monetary and trade integration deepens. In particular, trade links and exchange rate pegs can transmit shocks from one country to another and make business cycles more similar. Since trade of the CEECs with the EU has significantly increased over the transition period, and since several accession countries have pegged their currencies to the Deutschmark, subsequently replaced by the Euro, we face a sort of natural experiment for testing the endogeneity hypothesis.
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