Impact of Exchange Rate in the Run-Up to EU Accession: An Empirical Analysis of Republic of Macedonia

Abstract

Because of the fact that South-eastern European countries rely mainly on exchange rate anchors to reduce inflation, the appreciation of the real exchange rate among countries in the region is significant, and it is slightly lower when it’s compared with the EU member states. As a result, these countries suffer from loss of competitiveness. This can be clearly seen from the movements of the deficit on their current account, which is important in all these countries. Using the exchange rate as anchor for inflationary expectations, on long run it has been identified as effective, producing a low and stable inflation rates. Therefore, Macedonia needs to address important challenges through determined implementation of structural reforms to cope with competitive pressures and market forces within the EU. Progress with structural reform scan help for macroeconomic stability, for example, by reducing the structural external deficits. Also, it helps nominal convergence, as the productivity realizes the improvement of competitive ness and helps disinflation by maintaining low unit cost.In terms of macroeconomic convergence, EU membership requires convergence of the Macedonian economy with that of the EU in realistic conditions, indicating income per capita and economic structure, and in nominal terms, meaning convergence of prices, inflation and interest rates. In this paper, we focus on impact of exchange rate in small and open economy like Macedonia, to be seen in the context of continued integration of supply chains. Further we underline that membership into European Union can improve the situation of Macedonia only if the access to a large extent makes Macedonia location from which foreign investors can serve to the EU market,meaning that the domestic industry with the help of FDI must take the necessary change of its output. Also with the support of estimations, in this paper, we showed that in a small and open economy, such as Macedonia, using real exchange rate as an instrument could be realized the opportunity for growth of export performances, increasing aggregate demand and increasing economic growth thus speeding the convergence process to EU.