Bargaining for Costs of Convergence in the Exchange-Rate Mechanism II

Abstract

The Exchange-Rate Mechanism II (ERM II) is a Maastricht convergence criterion with which Central and Eastern European Countries (CEECs) must comply before they are admitted to the European Monetary Union (EMU). However, EMU accession is not a 'free lunch' as it entails so-called costs of convergence. Starting from the point of view that these new members of the European Union (EU) are in fact credibly committed to joining the EMU for political reasons -that is, ensuring political stability in CEECs -it is demonstrated that CEECs are able to pass some costs of convergence on to current EMU members: CEECs will under identifiable conditions threaten to halt the entire enlargement process by putting their exchange-rate regimes and, as a result, political stability at risk. In line with this rationale, the entire process of transition within ERM II, can be modelled as a twostage threat game, which may be solved by a Rubinstein bargaining solution.KEY WORDS • EMU enlargement • Rubinstein bargaining • threat game

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“…The structure of the game is shown in detail in figure 1. In doing so, we rely on Fahrholz (2007); further, e.g., Fahrholz and Wójcik (2012) and Arghyrou and Tsoukalas (2010) deal particularly with the Greek sovereign debt crisis.…”

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“…A hallmark of the model is that haggling over fiscal adjustment costs is captured in a bargaining that renders the entire threat game analytically as well as empirically tractable (see also Fahrholz (2007)).…”