{"id":7667,"date":"2023-08-21T11:53:00","date_gmt":"2023-08-21T11:53:00","guid":{"rendered":"https:\/\/axevera.com\/2023\/08\/21\/exchange-rate-czech-r-vs-slovakia\/"},"modified":"2025-06-30T08:58:34","modified_gmt":"2025-06-30T08:58:34","slug":"exchange-rate-czech-r-vs-slovakia","status":"publish","type":"post","link":"https:\/\/axevera.com\/en\/2023\/08\/21\/exchange-rate-czech-r-vs-slovakia\/","title":{"rendered":"Exchange rate: Czech R. vs Slovakia"},"content":{"rendered":"

How exchange rate influence country GDP dynamics: evidence from Czech Republic and Slovakia<\/strong><\/h2>\n\n

Fixed vs floating exchange rate.<\/strong><\/h3>\n

After the peaceful dissolution of Czechoslovakia in 1993, the Czech Republic and Slovakia pursued divergent economic policies, leading to differences in their exchange rate regimes. As capital account liberalization advanced in the mid-1990s, the “impossible trinity” posed an issue for the two countries, requiring a choice between being floaters or pegs.<\/p>\n

Every country adopts a specific exchange rate regime based on its policy objectives, economic circumstances and stability preferences. In the case at hand, the two countries namely the Czech Republic and Slovakia adopted contrasting exchange rate policies. The former maintained a floating exchange rate choosing to retain its own currency and allow it to adjust based on market forces; while the latter joined the Eurozone in 2009 and fixed its exchange rate to the Euro.<\/p>\n

Floating and fixed exchange rates have different advantages and disadvantages to consider. Regarding fixed exchange rates, the main advantages consist of boosting trades and lower transaction costs, promoting market integration and economic efficiency, and thus guaranteeing stability.<\/p>\n

Moreover, floating allows for monetary policy independence, in which a country can tailor shocks response based on their domestic needs without the constraint of maintaining an exchange rate target. Being economically resilient was aligned with the goal of the Czech Republic in preserving its monetary autonomy and staying out of the Euro.<\/p>\n

Czech Republic vs Slovakia <\/strong><\/h3>\n

The Czech Republic\u2019s transition from a centrally planned economy to a market-oriented one gradually prompted the country toward greater flexibility in its exchange rate regime. This decision gave the country monetary policy independence and the exchange rate\u2019s ability to adjust flexibly to market forces. However, the disadvantages of floating became apparent during the early years of this transition, when the Czech koruna experienced significant fluctuations, creating uncertainty and impacting trade competitiveness. Depreciations of the Czech koruna also led to imported inflation, that in turn reduced purchasing power and affected the standard of living. Conversely, the less-developed Slovakia had low levels of credibility and foreign exchange reserves that coupled with fiscal and external deficits led the country to opt for a fixed exchange rate, joying the Eurozone in 2009. This decision boosted Slovakia’s trade, which eliminated trade-hindering costs, enhancing integration and economic efficiency. This helped Slovakia to attract foreign investment and anchored inflation expectations. However, the unilateral pegging came at the cost of sacrificing monetary policy autonomy, which limited Slovakia’s ability to adjust the exchange rate to address competitiveness or external imbalances. Without cooperative outcomes with Europe, Slovakia remains vulnerable to broader EU economic shocks, which may lead to higher stabilization costs. This vulnerability was evident during the Eurozone Crisis (2011-2015). Member economies lacked the flexibility of tailored monetary policies to combat the recession, resulting in the implementation of monetary contractions to maintain the peg, which further decreased their outputs. In contrast, the Czech Republic better mitigated the decline in GDP by leveraging its ability to devalue its currency against the euro, as depicted in Panels A and B. The LM-IS-FX framework can provide further insights into these dynamics.<\/p>\n

Being economically resilient was aligned with the goal of the Czech Republic in preserving its monetary autonomy and staying out of the Euro. aIn fact, it allowed to lower interest rates in response to the global financial crisis and mitigate the Eurozone crisis\u2019s impacts on GDP (Panel B) by letting the Czech koruna depreciate (Panel A). On the other hand, floating regimes are highly volatile and might create uncertainty for international investments and trades, sometimes leading to inflationary pressure and financial instability. Consequently, the Czech Republic was not completely safe from the financial contagion of the Eurozone crisis.<\/p>\n

Overall, Panel A shows that in the early 1990s, both currencies significantly depreciate due to the fall of Communism and the shift towards an open economy. Subsequently, the adherence to Europe by the Czech Republic and Slovakia since the 2000s caused the currencies to appreciate.<\/p>\n

\u00a0<\/strong><\/p>\n

Eurozone crisis macroeconomic consequences <\/strong><\/h3>\n

The Eurozone crisis resulted in a loss of confidence and increased uncertainty among consumers and businesses. Governments introduced austerity measures to reduce budget deficits and debt levels, which involved cutting public spending and raising taxes. These measures caused a decline in EU aggregate demand, shifting the IS curve to the left and leading to a recession (Graph A). To revive the economy, the ECB implemented a monetary expansion, shifting the LM curve to the right. While this policy presumably increased output to its initial level (Panel B), the lower interest rates led to a decline in domestic return, causing the EU-CZK exchange rate to depreciate (Graph B).<\/p>\n

The depreciation resulted in a leftward shift of the foreign return in the Czech Republic’s forex market (Graph D). This was reflected in an initial appreciation of the CZK-EU exchange rate, which negatively impacted the Czech trade balance, shifting the IS curve to the left through the expenditure switching effect (Graph C). Due to its monetary policy autonomy, the Czech Republic could freely increase its monetary supply, boosting output above its previous value (Panel B and Graph C). This led to lower interest rates and a corresponding decrease in domestic return, causing the Czech koruna to depreciate strongly against the euro (Graph D and Panel A).<\/p>\n

In conclusion, significant public opposition emerged from the Eurozone crisis, deterring the Czech Republic from adopting the euro. Nevertheless, the exchange rate regime\u2019s choice ultimately depends on a country\u2019s economic priorities and assessment of the associated risks and benefits. As history demonstrated, countries have consistently adapted their exchange rate systems, transitioning between floating and fixed arrangements to cope with the ever-changing dynamics of the world.<\/p>\n

Edited by: Ginevra Angheben & Margherita Angheben<\/p>\n

Graphic source: https:\/\/storyset.com\/<\/p>\n

References<\/em><\/p>\n

Beblav\u00fd, M. (2002). Exchange Rate and Exchange Rate Regime in Slovakia\u2013Recent Developments. ResearchGate<\/em>. https:\/\/www.researchgate.net\/publication\/311570945_Exchange_Rate_and_Exchange_Rate_Regime_in_Slovakia-Recent_Developments<\/a><\/p>\n

Feenstra, R., & Taylor, A. (2021).\u00a0International Economics<\/em>\u00a0(fifth edition). Macmillan Learning.<\/p>\n

Hel\u00edsek, M., & Mentl\u00edk, R. (2018). The choice of exchange rate regime for Czech koruna in the context of ERM II participation and the related risks. Journal of International Studies<\/em>. https:\/\/doi.org\/10.14254\/2071-8330.2018\/11-1\/9<\/a><\/p>\n

The Editors of Encyclopaedia Britannica. (1998, July 20). Czechoslovakia | History, Map, & Facts<\/em>. Encyclopedia Britannica. https:\/\/www.britannica.com\/place\/Czechoslovakia<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"

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