Convergence expectations and convergence strategies : lessons from the Hungarian experiences in the pre-EU period

Eurozone convergence provides a unique opportunity for accession countries to abandon macroeconomic stabilisation policies that suffer from weak credibility. On the other hand, expectations of future improvements in macroeconomic variables and trend appreciation of the currency may undermine the relationship between interest rates, exchange rates and economic fundamentals, making the economy vulnerable to sudden changes in market sentiments regarding the timing and path to Eurozone accession. Recent developments in Hungary illustrate the impact of changing expectations on exchange rate and interest rate volatility. Two lessons can be drawn from the Hungarian experience. First, benign market sentiment and easier access to finance does not imply less pressure to correct macroeconomic imbalances in the long run. Second, convergence strategies should be robust with respect to sudden shifts in capital flows. Programmes should maintain the shock absorbing capacity of fiscal and monetary policies and offer a contingency margin to ensure compliance with the announced adjustment plan in case of unforeseen developments. Slower convergence programmes might be more successful. (Comparative Economic Studies / SWP)