The Dangers of Premature Euroization

Thirteen years after the fall of the Berlin Wall, the postcommunist countries of Central and Eastern Europe stand poised to join the EU, uniting Europe at last. The price of reform has been high. But all the hard work these states have undertaken to prepare themselves for EU membership may be squandered should they choose to adopt the euro too soon.

It is widely believed, even among the most Euro-skeptical of observers, that joining the eurozone will affirm these countries' successful transformation into modern market economies. Of course, the common currency's net long-term political and economic benefits are clear. But timing matters. Advocates of rapid euroization argue that it will promote and lock in fiscal, financial, and labor market reforms while expanding trade and boosting income.

But the evidence for believing that euroization can precede sufficient institutional reforms is scant. Moreover, it is based on the experiences of diverse emerging-market countries whose relevance for postcommunist economies is questionable. By contrast, euroization so far has required a fair degree of prior fiscal consolidation, a credible and independent monetary policy, reasonably competitive financial institutions, and flexible labor markets.

The debate about the timing and technical form of euroization must address which monetary regime--full-fledged euroization or floating exchange rates--is more effective in lowering risk premiums in the candidate countries. Smooth convergence of risk premiums for inflation, exchange rates, and, perhaps most importantly, debt default with those prevailing in the eurozone are crucial for alleviating possible shocks to the financial system. In hindsight, benchmarks of the candidates' ability to manage these risks should have supplemented the existing Maastricht criteria for adopting the euro.