We received the Euro Star. What next?
The experiences of the lats (and Latvia) over the past 20 years resemble a teenager's: studies in school are followed by exams, graduation and a step into the adult's life.
We started elementary school with a firm resolve to limit inflation, (a common affliction following the birth of a new market economy), by pegging the lat's exchange rate to the SDR basket of currencies in 1994. There was no euro then, and pegging the lats to only one currency, the Deutschmark or the US dollar, would not protect us as well from the currency fluctuations in our trading partners. The goal was achieved: within ten years, the Baltic countries were the only ones in the post-Soviet space that achieved price stability (low and predictable inflation), which is an essential precondition for sustainable economic growth. Up to this very day, some post-Soviet countries regularly carry out "devaluation" and yet another "currency reform" (i.e. robbing people of their savings).
Joining the European Union in 2004 and pegging the lats to the euro in 2005 was equal to Latvia entering secondary school. We were planning to introduce the euro (to graduate from secondary school) as early as 2008, but the overheated economy prevented us from meeting the inflation criterion (life temptations made the teenager temporarily abandon his studies).
We spent the next five years seriously preparing for our exams, often becoming the laughing stock of our neighbours. Wasn't it easier to get into the euro area through the back door: either manipulating the statistics as did the Greeks or introducing the euro "unilaterally" as did Montenegro? Yet we stubbornly persisted on our chosen course.
Finally, in the spring of 2013, we passed the exam: we meet the nominal convergence criteria set for joining the euro area (regarding the budget deficit, public debt, inflation and interest rates). The apologists for the "alternative course" became ever more grim as time passed: Latvian economy recovered, and much faster than the countries they suggested to be our peers.
The official exam results were published on 9 July 2013: as of 1 January 2014 we will start our adult life becoming the 18th member state of the euro area. The lats as a symbol of Latvian currency will become stronger instead of disappearing: it will find a new life in euro coins in the image of the Latvian maiden.
The Euro conference that took place on 12 September 2013 in Riga was our graduation in which we were presented with our diploma (the Euro Star). But as secondary school is just one of the first steps in a person's development, there is no reason to simply breathe a sigh of relief, throw the convergence criteria into the trash and think that now anything goes (the Greek example serves to prove that it is not the case).
On 12 September we received both congratulations (see the mass media) and wishes for the future, which seem to me much more important. I cannot vouch for the exact wording of the wishes, but this is essentially what the conference participants wanted to impart to us:
The future of Europe is unimaginable without a euro area. Yet euro changeover is no magic wand.
The euro will represent huge opportunities for economic development but it will not put everything in order for us.
Ensuring nominal convergence is only the first step; real and institutional convergence must be achieved.
Fundamentally (in the long term) it is not important during which phase of economic cycle Latvia joins the euro area. Let the prophets of an alternative course scare each other with the GDP quarterly growth figures: instead I will emphasize what will be topical even a few years down the road:
Joining the euro area is a logical step if we are sure of the construction of the European Union.
Latvia is joining the euro area at the right moment.
By joining the euro area, Latvia will be at the core of Europe and participate in shaping its future.
Just as Riga is never ready, neither the euro area, nor the Latvian economy can rest on their laurels:
The European Central Bank implements monetary policy ideal for an "average" euro area country that does not exist.
No country in the euro area would now vote for leaving it.
Disintegration is not the right direction. The euro represents only the beginning of integration
What are the particular things that the euro area should improve? Here we are not talking about managing the economic cycle (ensuring a positive GDP growth in the next quarter). We have issues on the agenda that, albeit not yielding profit right away, will be the ones that will determine the performance of the world's second greatest economy in the decades to come: an even tighter cooperation, including non-monetary issues, observing fiscal discipline, raising competitiveness with the help of structural reforms:
The monetary union should be expanded to banking, fiscal and political union.
The ECB guarantees liquidity, but not solvency. We have a common monetary policy, but the financial system is still national: it is a problem that has to be addressed as soon as possible. (Lucrezia Reichlin)
Emergency situations usually call for emergency measures. An unusually soft monetary policy may stabilize the financial situation, give governments extra time to improve their fiscal position, but it cannot replace structural reforms or to increase the growth potential.
Countries, which implemented a pro-cyclical fiscal policy during the boom, had only limited (if any) possibilities to provide fiscal relief during the bust, because they had no access to market financing. Only countries with a restricting fiscal policy during the good times can soften it during a recession.
Right now, Latvia has overcome its cyclical downturn: the output gap is zero or close to zero. Thus the unemployment rate is close to its natural level. The challenge for the future is to increase the potential (balanced) rate of economic growth and to reduce the natural rate of unemployment:
Latvia eliminated its macroeconomic imbalances. Future challenges are of structural nature.
What must Latvia avoid and what should it do?
It is important to prevent a repeat or the boom-bust cycle after the euro changeover.
Latvia must continue to increase its competitiveness; we must raise productivity, which is a determining factor of prosperity, particularly in industry.
The euro (the secondary education diploma) by itself is no guarantee of anything. It is only an instrument that provides us with opportunities for further development. If we use these opportunities, we are on the threshold of positive change. Therefore, as usual and as always, our future is in our hands.