Exchange rate variability as an OCA criterion: Are the candidates ripe for the euro?

Abstract

One measure of whether the candidate countries in Central Europe should join the euro is the degree of real exchange rate variability they are experiencing at present. If it is high one could argue that they 'need' still some exchange rate flexibility to absorb asymmetric shocks. Our results suggest that the still remaining variability of real exchange rates in Central Europe might be mostly due to the fact that nominal exchange rates are still a source of shocks. The candidate countries have already now a lower degree of exchange rate variability (after taking into account the different degree of nominal variability) than the 'Club Med' countries during the early 1990. Moreover, the traditional OCA criteria, e.g. trade structure, do not seem to be related to real exchange rate variability. This reinforces the argument that there is little concrete evidence that the candidate countries would need to undergo a lengthy period of real convergence before they should join the euro.