Friday, April 13, 2007


As a fast growing Baltic tiger, Estonia enjoy high rates of GDP growth and real convergence rate. Macroeconomic policy has successfully streamlined to attest the economic dynamism fueling Estonian growth. The country nearly fulfilled the Maastricht criteria on its way to Euro integration except for a bit of temporarily higher inflation rate consequently because of "catch-up" effects associated with convergence, and higher energy prices and EU-related tax hikes as exogenous pressures. Inflation indeed remained slightly higher than the euro area but distinctly anchored with nominal goals such as sustainable competitiveness under a fixed exchange rate regime. Inflationary expectations were low despite being raised several times in the highlight period of the report issued by the European Commission tackling Baltic tigers to further curb inflation beyond the average rate of three countries in the EMU having the lowest inflation rate.

Taking both, endogenous and exogenous factors into account, there is some particular asymetric reversion in this case. Slightly higher inflation rate comprises the enhancement of GDP convergence. In this case, it seems that the European Commission got frustrated by liberal economic institutions and competitive regulatory framework which enables Estonia to sustain higher growth rates on the basis of long-term estimation. In fact, Estonia has fulfilled all other listed Maastricht criteria. The country's macroeconomic situation is appraised by a low proportion of public spending and a strong fiscal "surplus" stance currently targeted at 1,8 percent of the GDP. Estonia has long been the pioneer of the culture of sound monetary practice on behalf of responsible policy-making of the Central Bank which brought the inflation pressures, emerging from expansionary monetary policy, effectively under control. Further, Estonia was the first ex-communist country to launch the liberalization of the financial sector. To avoid the real long-run inflation pressures, Estonia is ought to enhance the flexbility of labor market which could in turn, as a consequence of possible overheating, play a vicious role in triggering a pressure on inflation in claiming fiscal stimulus and wage growth through collective bargaining ignoring the productivity dynamics. Such a scenario happened in Slovenia in early 90s.

There is an open question touching the EMU rules which are ought to be respected by each member country. How can countries such as France ignore the Maastricht criteria, say, the budget deficit and an extraordinarily high GDP consumption rate? Instead of praising Estonian efforts to turn the fiscal stance into the surplus and maintain a low public debt, the European Commission denied Estonia, Latvia and Lithuania the Euro entry though slightly higher inflation rate did not follow from an irresponsibly behavior of the central bank but it resulted from what the European Commission and the EU are constantly talking about - GDP convergence in the framework of stability and vibrant macroeconomic environment.

There certainly are benefits from Euro and EMU membership such as the elimination of risk associated with having a separate currency, the ease of transaction costs and further fostering economic integration. But EMU membership demands a sound institutional framework and competitiveness to further boost producitivity which supports GDP growth rates. We can also see that in case of irresponsible fiscal policy and uncontrollably undertaken structural measures, Euro does not help to pursue streamlined objectives as in case of Italy, France and Germany.

Stefan Karlsson gave a thorough perspective on the question of Baltic integration into the Euro zone.

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