Joining the Euro Zone: From the Perspective of Emerging Europe Countries

Abstract

There were the two main factors behind the recent boom-bust cycles in some of the euro- zone countries. The first was the negative feedback loop between the high rate of growth in loans and a fall in real interest rate. The second was the growing use of external funding by local commercial banks. The same factors caused unsustainable lending booms in several CESEE countries. The Baltic states could not suppress the negative feedback loop between a high rate of credit growth and a fall in real interest rate because under the currency board regime they were not able to rise interest rates. However, unsustainable lending booms occurred also in these CESEE countries that had autonomy of setting interest rates, because effectiveness their monetary policy was impaired by a rapidly growing volume of foreign exchange loans. The recent experiences with unsustainable lending booms in several European countries demonstrate that the euro-zone accession countries should be equipped with a set of effective macro-prudential tools that would shield their economies from the risk of boom-bust cycles after joining the monetary union.