Table of Contents

Financial and Monetary Integration in the New Europe

Financial and Monetary Integration in the New Europe

Convergence Between the EU and Central and Eastern Europe

Edited by David G. Dickinson and Andrew W. Mullineux

Potential new entrants to the European Union from Central and Eastern European countries face many challenges to achieve financial convergence with the existing EU nations. Using detailed case studies from Bulgaria, the Czech Republic, Latvia, Lithuania and Poland and analysis of cross country data from these regions, Financial and Monetary Integration in the New Europe looks at the key issues for applicant countries as they negotiate the terms of their membership in the European Union. Of major concern to these countries is the financial sector and its implications for economic growth and the conduct of macroeconomic policy. The book examines, in particular, monetary and exchange rate policies, banking regulation and financial market efficiency. The overall impact of building a market driven financial system on economic development is also explored.

Chapter 8: The currency board regime in Bulgaria and its sustainability

Tatiana Houbenova

Subjects: economics and finance, financial economics and regulation

Extract

Tatiana Houbenova INTRODUCTION The failure of discretionary monetary policy to prevent accelerating inflation during 1995Ð97 forced the adoption of a currency board arrangement (CBA). At the beginning of the banking crisis, the monetary authorities were faced with a dilemma: weakening confidence in the national currency could not be countered with an interest rate increase which would further harm an already weak banking system and put additional pressure on the budget. At the same time, liquidity had to be provided to banks (both solvent and ailing) facing withdrawals in an attempt to prevent the crisis from becoming systematic. Even with this constraint, monetary policy was inconsistent and ultimately provoked the inflationary consequences of the banking crisis. The attempts to use the exchange rate as a nominal anchor while providing uncollateralized refinancing to insolvent banks caused an irreversible depletion of foreign reserves. Once the official reserves fell below a certain threshold, the banking crisis turned into a general confidence crisis. The belated attempts to use the interest rate to stabilize money demand failed in spite of its drastic jump to more than 800 per cent on an annual basis. During the autumn of 1996, it had become clear that in order to restore confidence in domestic currency, a dramatic shift in policy was needed. A complete regime change centred on a CBA was deemed necessary to restore confidence in public institutions and give credibility to monetary and fiscal policies. The CBA was put in place as a key element of a...

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