The orientation of economic policy in these areas will have to focus strongly, at the level of both national authorities and European institutions, on consistency, flexibility and credibility if we are to extract the maximum gains for all out of this next step in European integration. Long run net benefits of euro adoption In order to place this topic in its proper context it is first important to recall that the adoption of the euro is expected to produce significant net benefits for the NMS in the long run. A consistent body of literature points to the likelihood of substantial output growth arising out of increased external trade in countries forming currency unions. Recent studies suggest trade gains of between 6% and 15% from the creation of the euro after five years of its existence. 1 On the basis of these estimates, euro adoption could raise GDP by at least 1% to 2% over 20 years in the NMS. 2 These gains arise from the elimination of exchange rate volatility and risk, lower transaction costs, increased competition and price transparency, all of which lead to trade creation. Lower risk premia on borrowing costs and the stronger frameworks for policy discipline prevailing within the euro area are other potential sources of economic growth.
Such considerations will no doubt have played a part in the recent decision by the six members of the Gulf Cooperation Council to seek the advice of the European Central Bank (ECB) in developing a blueprint for forming a currency union and introducing a common currency by 2010. In a similar context, the announcement last week that Iceland is considering joining the euro is most significant. The country’s Prime Minister is reported to have said, “It’s clear [that] it’s not easy to run a small economy and a small currency in a big market”. There will also, of course, be long-term costs arising from the adoption of the euro associated with the loss of monetary and, particularly, exchange rate policy autonomy. Studies based on the Optimum Currency Area (OCA) criteria, however, suggest that NMS are not likely to suffer from a more pronounced incidence of asymmetric shocks than the existing non-core euro area members. 3 Moreover, the nature of shocks to which the economies of these countries are generally subject do not  1  Faruqee (2004)  2  Schadler et al (2005)  3  Fidrmuc (2001), Boreiko (2002)  BIS Review 53/2006  1  necessarily require intervention on the nominal exchange rate, provided that more efficient mechanisms for aggregate demand management are in place.