Labor Market Implications of Switching the Currency Peg in a General Equilibrium Model for Lithuania

On February 2, 2002, Lithuania switched its currency anchor from the dollar to the euro. While pegging to the dollar (since April 1994) has proven successful throughout the transition years, the recent decision to peg to the euro was motivated by the increasing trade relations with European economies. This paper does not argue which peg is more appropriate, but it analyses the implications of changing the exchange-rate regime for different sectors and labor groups. While pegging to the euro entails more stability for the exporting sector, Lithuania is still very dependent on dollar-based imports of primary goods from the CIS economies, more so than other Baltic countries or Central European economies. This study uses a multi-sector general equilibrium model to compare the effects of dollar-euro exchange-rate movements under these alternative pegs. Overall, simulation results suggest that while a euro-peg will provide more stability to GDP and employment, it will also imply more volatility in prices, suggesting that under the new peg macroeconomic policy should be more concerned with inflationary pressures than before. From a sector-specific perspective, pegging to the euro will provide a more stable demand for unskilledintensive manufacturing and commercial services. However, other sectors such as agriculture, will still face the same vulnerability to exchange-rate movements. This suggests that additional policy measures may be needed to compensate sector-specific divergences. * The findings, interpretations, and conclusions are the author’s own and should not be attributed to the World Bank. The author may be contacted at: [email protected] .