Economic catching-up and monetary integration of Central and Eastern European countries.

Summary This thesis focuses on the challenge of price level catch-up for macroeconomic stability in the transition countries of Central and Eastern Europe, in view of their future participation in the euro area. In this respect, a model of the equilibrium real exchange rate suggests that the real appreciation linked to economic catching-up conceals different relative price evolutions according to the exchange rate regimes, which are reflected in contrasting external debt trajectories. In flexible exchange rate economies, the rise in the nominal exchange rate favors an endogenous appreciation of the terms of trade in the medium term, by directing foreign direct investment and the realization of productivity gains towards the exposed sector of the economy, which translates into an appreciation of the equilibrium real exchange rate and an improvement in the external accounts. In fixed exchange rate economies, the valuation effects of higher relative domestic prices tend to shift investment to the sheltered sector of the economy, leading to an erosion of external competitiveness, as evidenced by the rise in external debt. Moreover, monetary integration entails specific risks for the macroeconomic stability of catching-up economies, insofar as it is accompanied by a marked process of convergence of financing conditions between member states, as soon as the prospect of joining the common monetary area becomes credible. A dynamic rational expectations model shows that, in the face of the demand shock linked to such financial convergence, the appreciation of the nominal exchange rate proves crucial in limiting the overheating of the economy. Conversely, in economies with a fixed exchange rate, the lowering of country risk premia is likely to provoke a rise in external debt, followed by deflationary chains once in the monetary union.