EURO ADOPTION IN POLAND: IMPLICATIONS FOR MACROECONOMIC VOLATILITY

Abstract

Poland has joined the European Union and is set to join the European Monetary Union (EMU) in the near future. Euro area membership involves potential costs and benefits. On the one hand, Poland will abolish the zloty/euro exchange rate and, as a result, transaction costs and exchange rate risk within the single currency area will be eliminated. On the other hand, it is argued that a single currency area implies the costs stemming from the sacrifice of autonomous monetary stabilization policy, which allows for an independent interest rate policy, and an exchange rate adjustment mechanism in the presence of country-specific shocks. This dissertation focuses on a quantitative assessment of the economic costs of joining the EMU. The evaluation of the volatility of main macroeconomic variables under the current inflation targeting regime and fixed exchanged rate is performed within an optimizing dynamic general equilibrium model of a small open economy with nominal rigidities. Model dynamics under terms of trade and world interest rate shocks are investigated. We find that the euro adoption implies a higher macroeconomic volatility. Analyzing the impact of terms of trade shock, the inflation targeting regime is more favorable, as an inability to devalue the currency under the euroization scenario leads to a slower recovery in demand for non-tradable goods and thus consumption. Considering the impact of a sudden decline in the world interest rate, an excessive zloty appreciation and the tightening of monetary policy under inflation targeting pushes the economy into a deeper recession compared to the adoption of the euro regime, while long-run implications are almost the same for the two scenarios.