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Contents

I. Summary
  Quantifying costs and benefits
  Abandoning monetary autonomy and the effect on business cycles
  Timing of joining the euro area
II. Hungary's maturity for euro area participation
II.1. Hungary and the less advanced EU member states five years prior to currency union membership
II.2. Equilibrium level of Hungarian inflation in the event of entry into monetary union
III. Costs of joining the euro area
III.1. Integration and structural similarity
III.1.1. Similarity of economic structures
III.1.2. Integration of the Hungarian economy into the euro area
III.1.3. Business cycle linkages
III.2. Adjustment to asymmetric shocks
III.2.1. Price adjustment
III.2.2. Wage adjustment
III.2.3. Labour mobility
III.2.4. Adjustment via fiscal policy
III.2.5. Financial integration, international risk sharing and asymmetric shocks
III.3. Effects of the common monetary policy
III.3.1. Optimality of the uniform interest rate policy for the Hungarian economy
III.3.2. Efficiency of monetary transmission
III.4. Seigniorage loss as a result of entering monetary union
IV. Benefits of joinig the euro area
IV.1. Gains from reduced transaction costs
IV.2. Gains from foreign trade expansion
IV.3. Benefits of a reduction in exposure to financial contagion
IV.4. Effect of falling real interest rates and more favourable opportunities to borrow abroad on economic growth
IV.4.1. Expected fall in real interest rates as a result of joining the euro area
IV.4.2. NIGEM model simulation
IV.4.3. Compact, calibrated exogenous growth model simulation
IV.4.4. Summarising the results of the NIGEM simulation and the compact calibrated model
V. Timing of euro area entry
V.1. Time schedule of accession
V.2. Elements of the Hungarian convergence programme and prospective costs of convergence
V.2.1. Fiscal adjustment
V.2.2. Reducing inflation
V.2.3. Prospective costs of convergence in the light of international experience
VI. Appendices
VI.1. Effects of negative external demand shocks on Hungarian gross domestic product
VI.2. Identifying supply and demand shock using structural VAR estimates
VI.3. The model used to estimate foreign trade expansion
VI.4. Description of the calibrated growth model
Glossary
References

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Summary

Accession to the Economic and Monetary Union is one of the most important steps in Hungary's European integration, which will entail abandoning the national currency and adopting the euro as domestic legal tender. For Hungary as a new member state in the EU, introduction of the euro will not be an option but an obligation. Nevertheless, new EU members will have some leeway to set the date of adopting the euro. Therefore, it is useful to analyse the likely costs and benefits of joining the euro area for Hungary and to define the choice of medium-term economic policy strategy in the light of the results of this analysis. The National Bank of Hungary would like to contribute to the formulation of an economic policy strategy by issuing this volume, which contains a cost-benefit analysis of the likely effects of the country's joining the euro area. This analysis is confined strictly to the economic benefits and costs of introducing the euro and is not intended to examine its other possible impacts, including, for example, the implications for politics and national security.

Adopting the euro will likely have a permanent impact on Hungarian economic growth. This impact will become evident through numerous channels. Bank staff have attempted to quantify and sum up the extent of this impact transmitted through the various channels. The findings of this analysis suggest that the introduction of the euro will bring about significant net gains in growth. However, welfare is influenced not only by the level and rate of GDP growth, but their stability as well. A widely fluctuating national income will produce lower welfare than a more stable one, even if on average the two income levels are identical. For this reason, it is important to examine whether joining the euro area will increase or mitigate the volatility of business cycles. In other words, the key question is whether Hungary and the euro area form an optimum currency area, that is whether the monetary policy of the euro area is capable of adequately substituting independent Hungarian monetary policy in smoothing out cyclical fluctuations. In the findings of this analysis, the euro area seems to be in most respects at least as optimal a currency area for Hungary as for less developed euro area member countries.

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