The Risk of Increasing Inflation As A Barrier for the Czech Republic ' s Access into the Euro Area

The Czech economy is ready to adopt the euro. The reasons for
the postponement of the euro adoption process are merely
political. People are skeptical when it comes to the euro (also
in the light of the existing debt crisis in the euro area);
consequently, political institutions do not promote the euro
introduction. Concerns thus remain. We can expect analogical
development in the Czech Republic as that of Slovakia or
Slovenia, as these economies are similar. Actual inflation did
not increase in either of the two countries; however, the
perceived inflation was quite high. The prospect of the euro
introduction depends on how to avoid worries about inflationary
implications of the introduction of the euro. The communication
and information campaign should focus on eliminating the
concerns about the euro introduction.


Introduction
Upon entering the European Union, each new Member State automatically commits to replace its national currency with the euro.The actual euro introduction date partly depends on the fulfilment of specific conditions (economic preparedness) and partly on the political will of each country.
The objective of this paper is to assess the economic and institutional preparedness for the euro introduction in the Czech Republic and specify the reasons this step has been postponed.The paper relies on the hypothesis that the preparedness for the euro introduction is sufficient.There are two reasons for rejecting the euro introduction in the Czech Republic: Both the Government and the central bank fear the existing situation and other perspectives of the euro area as well as the obligations arising there from them.

Abstract
The Czech economy is ready to adopt the euro.The reasons for the postponement of the euro adoption process are merely political.People are sceptical when it comes to the euro (also in the light of the existing debt crisis in the euro area); consequently, political institutions do not promote the euro introduction.Concerns thus remain.We can expect analogical development in the Czech Republic as that of Slovakia or Slovenia, as these economies are similar.Actual inflation did not increase in either of the two countries; however, the perceived inflation was quite high.The prospect of the euro introduction depends on how to avoid worries about inflationary implications of the introduction of the euro.The communication and information campaign should focus on eliminating the concerns about the euro introduction.
The public is concerned about the implications of the euro adoption, particularly about rising inflation.Therefore, the paper focuses on such concerns about inflation, examining whether or not they are justified.
The structure of the paper is as follows.The literature review is followed by a brief analysis of the reasons for rejecting the euro in the Czech Republic.The next part assesses the preparedness of the Czech economy for the euro introduction, using the nominal and the real convergence criteria to the euro area.This is followed by an evaluation of the euro adoption perspective.
The next part examines the connection between the euro adoption and the price stability and inflation in terms of both short-term and long-term effects.The subsequent section explores the relationship between the actual and the perceived inflation, applying the perceived inflation quantification method in order to deduce any dependability of both types of inflation.The last part examines experiences of economies similar to the Czech economy, i.e.Slovakia and Slovenia, deducing potential implications of the euro introduction for the Czech economy.

The Conclusion summarizes key findings of individual sections of the paper.
In order to fulfil our objectives, we have used statistical data analyses (comparison of economic data for the Czech Republic and for the euro area), opinion poll results (Eurobarometer), and comparison of the development of the actual inflation and the perceived inflation for the Czech, Slovak, and Slovenian economy.

Literature Review
Accession of the Czech Republic to the euro area has been covered by a number of authors.One of the main opponents of the euro introduction in the Czech Republic is Mach, who summed up his arguments in his book Jak vystoupit z EU (How to leave the EU). .This is openly described by S. Janackova (2014, p. 97): "It no longer makes any sense to talk about our "obligation" to adopt the euro in connection with the major overhaul of rules that govern the functioning of the euro area.We certainly did not undertake to enter this euro area". 1 P. Mach (2012, p.

62) even fears that "[…] the European
Commission may decide about the membership of the Czech Republic in the euro area even against the will of the Czech Republic." 2 The decision not to set a specific euro area accession date is particularly substantiated as follows: 1) Changes in the euro area -new engagements The uncertainty regarding the institutional arrangement of the euro area had previously been seen as a "major barrier" to the euro adoption.This uncertainty has declined -as a result of the establishment of the European Stability Mechanism (ESM) and also a clearer plan for establishing a banking union.However, this is associated with new costs for the euro area members.The replacement of the Czech koruna with the euro would specifically result in the following costs 3 : -Contribute about CZK 51 billion within four years from the accession to the euro area as a registered capital of the ESM; moreover, additional contributions of up to CZK 391 billion would need to be made in case it is necessary to promote the credit ability of the ESM (however, this is very unlikely); The participation in the Single Supervision Mechanism (SSM, as of fall of 2014) will be associated with a fee of EUR 1.8  Detailed commentary should be addressed to the exchange rate criterion.The Czech koruna does not take part in the ERM II.
The reason for this is a strategy that "the Czech Republic would stay in ERM II for the minimum possible period".Therefore, the Czech Republic will only take part at the moment a date is set for the euro area accession.However, the fulfilment of the criterion can be simulated.
For this purpose, we will assume the approach of the ECB. 6As a starting point, we will use a hypothetical central parity at the level of the actual average exchange rate in the first month of the period under review, i.e.May 2012 (25.3133CZK/EUR).
The development shows maximum variations: -3.5% in terms of appreciation, -9.6% in terms of depreciation.
Considering the spread of the fluctuation range, i.e. 15% both ways, this criterion can be considered fulfilled. It

Real Convergence
In addition to the Maastricht (nominal) convergence criteria, countries adopting the euro should demonstrate sufficient level of the so-called real convergence to the euro area.It is mainly expressed via the following indicators: 1) Convergence of economic level that expresses the convergence of competitiveness of converging economies.This is important since independent exchange rate policy would no longer exist that would allow the country to affect its competitiveness through its national currency; 2) Convergence of price levels, which is important in terms of the development of inflation.In case of a significant difference in the price levels, there is a risk of sudden convergence of the lower price level of an acceding member to the higher price level of the euro area; 3) Alignment of business cycles that comply with the single monetary policy of the monetary union's single central bank.
In the area of economic level, the Czech Republic got to 78.5% of the euro area (18)  level in 2014.However, an indicator that compares the country's economic level with that of its main trading partners, to which the country's competitiveness is important, is more significant.Therefore, Particularly the second factor contributed to the departure of the Czech price level from the euro area price level -in 2008, the Czech price level amounted to 74.8% of the euro area average (17).Price convergence represents one particular area, where it is advisable to compare the price levels of acceding countries to those of their main trading partners, as opposed to the euro area level.Calculations suggest that the comparison of the Czech price level to the price levels of its three main trading partners would result in a 7 p.p. in 2013 (see Helisek, Mentlik, 2015).

Perspectives of the Euro Introduction
Many institutional measures have been taken in the Czech Republic in the course of the preparation for the euro adoption.These measures were also officially 6

___________________________________________________________________ in Business and
Particularly the second factor contributed to the departure of the Czech price level in 2008, the Czech price level amounted to 74.8% of the rea average (17).Price convergence represents one particular area, where it is advisable to compare the price levels of acceding countries to those of their main trading partners, as opposed to the euro area level.Calculations suggest that the of the Czech price level to the price levels of its three main trading lower gap in 2013 (see Helisek, Mentlik, 2015).
The correlation of the Czech business cycle to that of the euro area and the main trading partners can be expressed as the changes in real

Institutional Preparation 8
The main measures in the form of strategic decisions and institutional measures are as follows: • As of April 2011, the period of the so-called reduced preparations starts, with further preparations only consisting in, for example, the monitoring of foreign experience, informing the public through dedicated websites, revision of methodology papers, etc.

Current Perspectives of the Euro in the Czech Republic
The discontinued preparations for the euro introduction and the negative position of Czech Governments, coupled with the negative position of the central bank, have also been reflected in the views of the Czech public.Therefore, the development of public opinion (= views of voters) is related with the negative position of the new political representation -not only to the euro introduction, but to the European integration as a whole. 9The negative public opinion subsequently affected the decisions on further preparations for the euro introduction -these preparations were reduced.The lack of interest in the euro at the time was caused by the previous lack of interest in the euro.It is a phenomenon that is observed in the economics, e.g. with regard to the labour market development, described as the labour market hysteresis (current unemployment is caused by previous unemployment).With regard to monetary integration, the euro adoption hysteresis can be observed. 10 is also clear from ) 11 According to the Prime Minister, the euro could be adopted in 2020 12 or in 2019-2021according to the Minister of Industry and Trade. 13

Fear of inflation
As described in the book 10 years of euro:success?by Lacina, Rozmahel and Rusek, research results that rely on Eurobarometer surveys suggest that the price expressed in the original national currency is a benchmark for more than 50% of respondents in the newly acceding countries, for the minimum period of one year.For daily consumer goods this figure goes up to more than 70% of respondents 14 .Experiences with the fears of price increases caused that the fight against this phenomenon has become one of the key areas of practical preparations for the accession into the euro area in new EU Member States.

Legal requirements:
usage of dual display of prices and other selected monetary amounts, In the case of the Czech Republic, 73% of respondents are convinced that the euro introduction will result in price increase, 19% of respondents believe the prices will remain stable, 3% of respondents think the prices will be reduced, and 4% of respondents believe the euro introduction would not have any effect on prices. 15ecialized materials show that there are no objective reasons for prices to increase following the euro introduction; however, the aforementioned results indicate that The fears of inflation due to euro introduction, which are stated by the aforementioned Eurobarometer survey, are not surprising.These fears have also been present in new Member States, which already have euro already adopted.Specifically, in Slovakia, the actual inflation right before the euro introduction was almost 3%, however inflation expectations were much higher.In Slovenia, there were even larger concerns.Data about the actual and expected inflation are in Figures no. 1 and no. 2 in the attachment.

Actual and perceived inflation
The essence of perceived inflation is, that even though an actual (officially measured) inflation does not show any extraordinary increases during the euro introduction period, the public is generally convinced that the euro changeover resulted in higher inflation.
However, some subsequent research studies that focused on explaining the aforementioned phenomenon brought many interesting findings: • The inflation increase resulting from the rounding off of converted amounts/prices was estimated at about 0.3 p.p. 17 • The significant variation between the actual inflation and the perceived inflation was promoted by the psychology of consumers' perception of price changes that is more sensitive to price increases than to declining prices, tends to apply partial adverse experiences to the overall development of prices, and is unable to weigh the overall increase for individual items by their share in the total expenditure.
• inflation pressures were blamed on the euro, although many of them (tax adjustments, weaker euro exchange rate, rising energy prices, etc.) were not immediately related to the euro introduction.
Perceived inflation falls within the category of psychological quantities that have their own measurement processes.The European Commission organizes and finances systematic public opinion surveys targeting the aforementioned area, entitled Business and Consumer Surveys.These surveys take place on a monthly basis, in the form of telephone inquiry.The questionnaire includes six questions that examine how respondents perceive price increases (expectations). 18e result of the measurements of perceived inflation is so called balance statistics, which shows consumers' opinions, using an index in the range from-100to +100: if the value is +100, all believe that prices increased significantly, if the value is -100, all believe that prices decreased.Tableno.5 shows that the actual inflation after the introduction of euro for cash payments fluctuated around 2%. Irrespectively of the aforementioned fact, consumers came to a conclusion that the euro introduction resulted not only in a price jump, but also in a permanently higher inflation.As shown in Table no.4, this feeling was dominant in all euro area countries with the exception of Finland.On average, in 12-euro area countries reached in late 2002 the index of balance statistics63 19 , which means the prevailing views on the impact of the euro introduction on the inflation increasing.
The difference between actual and perceived inflation (perceived inflation being higher than actual) was observed also in other new EU member countries.This difference was observed both in the case where the actual inflation rose (Slovenia), and in the case where the actual inflation fell (Slovakia) -see Figures in the Attachment.

Experiences in Slovakia and Slovenia with the inflationary impacts of the euro introduction
The euro introduction process in Slovakia and Slovenia confirmed that, similarly as in other countries adopting the euro, also here people were concerned about increase prices as a result of the euro changeover.In this regard, many parallels can be expected for the euro adoption in the Czech Republic.In spite of these negative expectations, they were largely successfully eliminated, and actual inflation didn't reach high levels, that were expected.That is illustrated in The actual inflation after the euro introduction in Slovakia (early 2009) was around 3%, however, expected inflation was higher.According to the official calculations of the National Bank of Slovakia, the impact of the euro changeover on inflation was ultimately lower than estimated -i.e.0.12 to 0.19 p.p. 20 These results were achieved by applying a set of several measures (mentioned in section 6), targeting the protection of consumers from any abuse of the transition to the new currency by merchants and businesses, which would have impact on the increasing of actual inflation.Of course, one of the factors that contributed to lowering the inflation (0.9% for 2009) was the economic recession in this year.
Another problem was to limit the perceived inflation from rising, and therefore limiting the negative stance of citizens towards the new currency.This was achieved in Slovakia by organizing an information campaign targeted at the general public, with special emphasis on the phenomenon of perceived inflation.Price surveys of selected consumer prices proved to be one of very effective instruments, with the objectivity and professionalism of such surveys ensured by the statistical office.These statistical surveys took place in regional cities several days after the euro introduction.Quick publication of results eliminated various speculations and assumptions, while also preventing any speculations on the part of the media.
Also in Slovenia, there were concerns about increasing prices following the euro changeover.In reality, inflation went down in January 2007 (following the euro introduction) compared to December 2006, as a result of end of season sales.The annual inflation decline from 3% to 2.8% in January was mainly caused by lower energy prices.Overall, the prices increased by 1.3% during the first months of 2007, compared to 1.5% in the same period of 2006.Throughout 2007, the inflation has been relatively high at 5.7%.This growth was caused by the inflation in the second half of the year going up due to the financial crisis.An independent study by the Slovenian Institute of Macroeconomic Analysis and Development expected the impact of the euro introduction on inflation at 0.24 p.p. 21 Similarly Eurostat quantified the impact of the euro introduction on consumer prices at 0.3p.p. 22 Overall, the experience in old and new member states of the euro area does not indicate inflationary impact of the introduction of the euro.In addition to these experiences existing development of inflation in the euro area must be taken into account as another factor that affects the inflation after the introduction of the euro (Table no.7).Inflation in the euro area is very low.In many countries was even mild deflation (Greece, Spain, Cyprus, Portugal, Slovakia, Finland) in the years 2014 and 2015.The European Central Bank fears of extension of deflation into other countries.In these circumstances, we can´t expect that the introduction of the euro causes the increasing of inflation.

Conclusion
Discussions relating to the euro introduction in the Czech Republic are topical.The following circumstances corroborate early introduction of the euro: -Most institutional preparations for the euro introduction have already been carried out; -Czech economy complies with the Maastricht convergence criteria (required nominal convergence); -The real convergence level to the euro area economy is sufficient as well; -There has been a positive change in the position of the significant part of the political representation in terms of the euro introduction with subsequent more positive views of the public on the euro.
The Czech Republic, as another country adopting the euro in subsequent stages, can capitalize on the knowledge and experience with prior introduction of currencies in other countries.Traditionally, the Czech Republic has been known as a euro-sceptic country, with the euro lacking strong support of the general public.Therefore, a thoroughly prepared information and communication campaign will be absolutely crucial for the euro changeover process.
The Czech Republic can use the experiences of the euro introduction in The correlation of the Czech business cycle to that of the euro area and the main trading partners can be expressed as the comparison of year-to-year changes in real GDP (Figure no. 1).The development of business cycles expresses about the same trend (namely the recession stage in 2009, recession or declining growth in 2012 2013).
Figure no. 2 that the views of the public regarding the euro X.02 III.03 XI.03 V.04 V.05 IV.06 IV.07 IV.08 IV.09 IV.10 IV.11 VI.11 IV.12 IV.13 IV.14 IV.15 for against introduction have changed since 2014.This has also been affected by political positions.A positive position on the euro introduction was expressed in the Policy Statement of the new coalition Government of the Czech Republic (January 2014): "The Government shall actively strive to create conditions conducive to the adoption of the euro.""The Government shall support steps towards the deeper coordination of economic and fiscal policy and towards the restoration of confidence in the European financial sector.It shall revise the existing reticent opinions on monetary integration and financial cooperation."(highlighted by M. H. MojmirHelisek (2017), Journal of Eastern Europe Research in Business and Economics, DOI:10.5171/2017.433556 MojmirHelisek (2017), Journal of Eastern Europe Research in Business and Economics, DOI:10.5171/2017.433556 Janackova is another opponent of the euro area enlargement process, particularly in her book Peripetie ceske ekonomiky a meny aneb nedejme si vnutit euro (Peripety of the Czech economy and currency, or, let's not have the euro forced on us).Various benefits and risks associated with the euro introduction are mainly covered in the book of Helisek et al. entitled Euro v Ceske republice z pohledu ekonomu (The euro in the Czech Republic from the perspective of economists).fortheeurointroduction are mainly included in the document National Euro Changeover Plan for the Czech Republic prepared by the NationalCoordination Group for euro changeover in the Czech Republic.In addition to this, there are many studies that examine the preparations for the euro introduction as well as the effects thereof, particularly the Studie vliv zavedeni eura(Study of the impact of the euro adoption(Lacina et al.).Detailed analysis of the perceived inflation phenomenon and of the relation of the actual and the perceived inflation is also included in the book of Dedek Doba eura.Uspechy i nezdary spolecne evropske meny(The era of the euro.Successes and failures of the common European currency).

Table 1 : Maastricht convergence criteria (%)
4ource: The processing of the authors on the basis of European Commission, 2014; European Central Bank, 2014.Notes: Period of assessment for the inflation and interest rate criteria = March 2013 -April 2014; for fiscal criteria = 2013; for the exchange rate criterion = May 2012 -May 2014.*"If the Council decides to abrogate its excessive deficit procedure, the Czech Republic will fulfil the criterion on public finances" (European Commission, 2014, p. 9).This process was abrogated in June 2014.Fulfilment of the price stability criterion and interest rate criterion can have assumed to be the same in the upcoming years.Rise of the harmonized index of consumer prices should remain stable around 2% and interest rate around 2-3%.4The public finance sustainability is also assumed within the Czech Convergence Program ofApril 2015.Table no. 2 contains the public finance development prognosis.

Table 2 : Czech public finance development prognosis (as % of GDP) 2014 2015 2016 2017 2018
Source: The processing of the authors on the basis of Ministry of Finance.Czech Republic.2015,p. 22.

Table 3 : Comparison of economic and price levels (2014, %) Czech Republic to: Economic level Price level
Table no.3 shows price convergence.The low price level convergence has been caused by the Depreciation of the CZK/EUR exchange rate Furthermore, Table no.3showsprice convergence.The low price level convergence has been caused by the following factors: Low Czech inflation; Depreciation of the CZK/EUR exchange rate as of November 2013.Figure 1: Changes in real GDP (year Source:http://ec.europa.eu/eurostat/tgm/table.do?tab=table&init=1&language=en&pcode=tec00115&plugi n=1

tab=table&init=1&language=en&pcode=tec00115&plugi Perspectives of the Euro Introduction Many
).The development of business cycles expresses about the same ely the recession stage in 2009, recession or declining growth in 2012institutional measures have been taken in the Czech Republic in the course of the preparation for the euro adoption.These measures were also officially ____________________________________________________________________ ______________ Roman Mentlik and MojmirHelisek (2017), Journal of Eastern Europe Research in Business and Economics, DOI:10.5171/2017.433556 http://ec.europa.eu/eurostat/tgm/table.do?

433556 Figure2: Development of public opinion concerning the euro introduction in the Czech Republic (%, 2001-2015)
The development of public opinion (= voters) is shown in Figure no.2.
___________________________________________________________________ _______________ Roman Mentlik and MojmirHelisek (2017), Journal of Eastern Europe Research in Business and Economics, DOI:10.5171/2017.Source: The processing of the authors on the basis of Czech Public Opinion Research Center, 2015, p. 2.Last survey of April 2015, 1011 respondents It is clear from Figure no. 2 that the negative position on the euro started to prevail at the turning of 2006 and 2007:

Table 5 : Actual and perceived inflation in euro area countries (2002-2004, average annual data)
Source: The processing of the authors on the basis of European Central Bank.2007, p. 64.