The impact of the crisis on the monetary autonomy of Central and Eastern European countries

Abstract

Where a country allows the free movement of capital and follows a free floating exchange rate policy, the monetary trilem-ma would suggest the existence of monetary autonomy, which is prejudiced when external shocks cause a significant decrease (divergence) or increase (contagion) in market co-movements. This study aims to analyse the extent to which daily changes in bond market returns and exchange rates of the Euro area, and the monetary policy measures of the European Central Bank (ECB) influ-enced the daily changes in the bond market returns and currencies of the Czech Republic, Hungary and Poland between 2002 and 2011. After rejecting the efficient market hypothesis for the capital and money markets under review, a dynamic conditional corre-lation is fitted to individual market pairs. Whether the differences between these are significant is analysed against extreme and nor-mal daily movements in Euro area indicators. A movement is considered extreme where the empirical movement is an outlier for the theoretical normal distribution applicable to it. Although the objective function of monetary policy in Central and Eastern European countries is mostly aligned with that of the ECB, owing to differences in their fundamentals, collective actions taken on extreme days caused risk premiums to increase. Consequently, Central and Eastern European markets were much harder hit by adverse changes in the Euro area, while the impact of the ECB’s measures to enhance liquidity was not necessarily felt. It is doubtful, however, that the introduction of the Euro would eliminate such unfavourable phenomena.