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From Tolar to Euro

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From Tolar to Euro Slovenia has managed the transition process well. Judi- From Tolar to Euro Editors: Velimir Bole, Landis Mac Kellar cious policy choices contributed to economic restructuring and stabilization, which facilitated the eventual adoption of, the Euro and the successful integration of Slovenia in the European economy. This book discusses the challenges encovun- tered during this process and the policy choices which led to Euro From Tolar adoption in January 2007. Dominique Strauss-Kahn, Managing Director to Euro International Monetary Found Slovenian Euro coins 4. naslovka 150x230.indd 1 4/16/10 11:53:31 AM 2 CONTENT STRATEGY FOR ENTERING THE EURO AREA Velimir Bole ..............................................................................................................7 DeterMinants OF INFLation IN SLOVENIA ON THE Road to Euro ADOPTION* Biswajit Banerjee and Haiyan Shi ...................................................................... 33 Monetary POLICY InstruMents IN THE PERIOD BEFORE THE ADOPTION OF THE EURO Mitja Gaspari....................................................................................................... 49 FISCAL POLICY ADJUSTMENT AND Coordination OF MaCroeCONOMIC POLICIES Dušan Mramor .................................................................................................... 71 PrograM FOR THE IntroduCTION OF THE EURO Andrej Rant .......................................................................................................... 83 Cash CHANGEOVER EXERCISE Božo Jašovič ......................................................................................................... 95 SLOVenia After Euro AdoPtion: ChaLLenges AND SOLUTIONS Thomas Dalsgaard ............................................................................................ 103 What DRIVES INFLation IN SLOVENIA?1 Jay Surti ............................................................................................................. 115 PENSION systeM ADJUSTMENTS Dušan Kidrič ..................................................................................................... 137 HEALTH SysteM REFORM IN SLOVENIA Armin Fidler and Inez Mikkelsen-Lopez ......................................................... 163 3 4 FOREWORD The choice of an appropriate exchange rate regime is never easy. An exchange rate regime should provide a credible anchor for macroeconomic stability and be consistent with the overall goals of the economic policy of a country. The choice of the appropriate exchange rate regime becomes even more challenging when a country experiences dramatic changes as Slovenia did since 1991. The economy moved from a socialistic to a market-based system; trade was redirected; and, finally, the economy became fully integrated with other European economies. The IMF has been engaged in this process and has all along maintained a very fruitful dialogue with the Slovenian authorities. Slovenia has managed the transition process well. Judicious policy choices contributed to economic restructuring and stabilization, which facilitated the eventual adoption of the euro and the successful integration of Slovenia in the European economy. This book discusses the challenges encountered during this process and the policy choices which led to euro adoption in January 2007. Slovenia was the first of the new member countries to adopt the euro, an achievement which crowned the country’s stabilization effort. However, as contributions in the book have made clear, several structural reforms, including in the areas of public expenditure, labor and product market regulation, and pensions, still need to be completed to build on the progress already achieved, and for Slovenia to fully reap the benefits of its true potential. While the current crisis has hit all economies hard—especially those more integrated with the global economy such as Slovenia—the country has weathered its consequences well. I am confident that Slovenia will continue to advance its reform agenda in the years ahead, and that its policy choices will provide good prospects for a strong and sustainable economic recovery. Dominique Strauss-Kahn Managing Director International Monetary Fund 5 Chapter 1 STRATEGY FOR ENTERING THE EURO AREA Velimir Bole INTRODUCTION Slovenia accomplished its transition to a market economy in two phases: a macroeconomic stabilization phase which lasted until 1996, and a structural adjustment phase which ended in 2000. Two additional phases were needed to enter the euro area: the “landing phase” which started in 2000 and ended upon entry into the European Union (EU) in 2004, and the “intermediate phase” which formally covered the Exchange Rate Mechanism II (ERM) II) period1 During the landing phase, crucial macroeconomic variables (inflation, fiscal balance, interest rates, and debt) were brought into line with Maastricht targets, while in the intermediate phase the sustainability of landing was established. Policy measures in both the landing and ERM II phases could be considered together as part of an overall policy package designed to accomplish the fastest possible entrance in the euro area. At the beginning of the process of adopting the euro, several structural shocks adversely affected macroeconomic performance and efficacy of economic policy.2 Macroeconomic deterioration, coupled with potential long-term opportunity costs of being in the EU but not in the European Monetary System, resulted in a drastic change in economic policy strategy. Two crucial principles of the new economic policy were avoiding second-best solutions and ensuring tight interplay between monetary and fiscal policy. This chapter discusses the main characteristics of the economic policy strategy for entering the Euro area. The relative contributions of monetary and fiscal policy are discussed, as are the means by which the economy was kept consistently on track towards the adoption of the euro despite shocks and resulting disequilibria. 1 Condensed presentation of the landing phase of Slovenian transition in this chapter is based on the material from several previous papers; see Bole (2002, 2003a, and 2003b) and Bole and Mramor (2006). 2 See, for example, Bole (2003a) or Bole and Mramor (2006). 7 The rest of the chapter consists of six sections. In the next section basic principles of the economic policy strategy are identified. Stylized monetary policy is presented in the third section, and stylized fiscal policy in the fourth sections. A formal model of the economic policy is presented in the fifth. Main findings are summarized in the concluding section of the chapter. MAIN REASONS AND PRINCIPLES OF POLICY MODIFICATIONS Structural changes At the beginning of the process for entering the euro area (i.e., from the second half of 1999 onward), there were three major structural changes that profoundly affected not only the economic policy concerning inflation and financial stability, but also the strategy of the entire policy for entering the euro area. First, in mid-1999, a value-added tax (VAT) and excise taxes were introduced, resulting in a jump in prices, a severe shift in relative prices in favor of services, and an almost complete pass-through of the price shock into wages. Second, due to a marked deterioration in the management of public sector finances in the late 1990s, the resulting chronic problems of insufficient tax revenues were systematically resolved by substantial rises in domestic taxes levied on goods and services and large increases in directly or indirectly regulated prices, which led, in turn, to additional supply price shocks. Finally, in mid-1999, all remaining restrictions on financial transactions with the rest of the world were abolished as a part of the EU accession process.3 These structural changes considerably weakened macroeconomic performance. The restructuring of the tax system, the changes in the management of public finances, and major revisions to indirectly and directly regulated prices significantly accelerated the growth of prices. For the same reasons, the relative prices of nontradable goods and services increased, even though they had already been far in excess of what would have corresponded to the Slovenian economy’s level of development. In the 1990s, from the very beginning of transition, producers’ market power in the nontradables sector was, namely, much higher than producers’ market power in tradables.4 The efficiency of foreign exchange interventions to sterilize inflows was drastically reduced by deregulating foreign financial flows, and it became impossible to set independent (policy controlled) paths for money supply and the exchange rate. 3 See, for example, Bole and Mramor (2006). 4 See Bole (2002 and 2003b). 8 Economic policy modifications for entering the euro area In the process of entering the euro area, economic policy was determined by three factors: deterioration of crucial economic performances at the beginning of the process, the short time span available prior to expected entry into the EU, and the evaluation of (potential) opportunity costs (risks) of being in the EU (and more so in the ERM II) but not in the common monetary area. At the beginning of the process of adopting the euro, macroeconomic performance measures were far from the zone acceptable under the Maastricht criteria. Only the public debt was within Maastricht limits. The structural changes described above were key contributors to weak macroeconomic performance.5 The main focus of policy modification was therefore on neutralizing these
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