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Nominal Versus Real Convergence - EMU Entry Scenarios for the New Member States

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Author Info
Paul Grauwe
Gunther Schnabl

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Abstract

This paper explores the conflict of real and monetary convergence during the EMU run-up of the Central and Eastern European member states. Using a Balassa-Samuelson model of productivity driven inflation, we find a high probability of higher inflation in the new member states. We compare the policy options which make the compliance possible, i.e. fiscal tightening and nominal appreciation within the ERM2 band. Nominal appreciation within ERM2 seems the better option to achieve the compliance with the Maastricht criteria, as no discretionary government intervention is necessary, and losses in terms of real growth are smaller. Having once opted for nominal appreciation by fixing the ERM2 entry rate as the central rate (Irish model), a high degree of flexibility is provided in coping with erratic short-term capital inflows. The strategy of setting the ERM2 entry rate above the central rate (Greek model) implies a clear exchange rate path within ERM2 and thereby less exchange rate volatility. Despite the merits of nominal appreciation, countries committed to hard euro pegs, or with high budget deficits, may choose fiscal contraction as a solution. Copyright © 2005 Blackwell Publishing Ltd..

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File URL: http://www.blackwell-synergy.com/links/doi/10.1111/j.0023-5962.2005.00301.x/enhancedabs
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Publisher Info
Article provided by Blackwell Publishing in its journal Kyklos.

Volume (Year): 58 (2005)
Issue (Month): 4 (November)
Pages: 537-555
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Handle: RePEc:bla:kyklos:v:58:y:2005:i:4:p:537-555

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  1. M. Frömmel, 2007. "Volatility Regimes in Central and Eastern European Countries’ Exchange Rates," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 07/487, Ghent University, Faculty of Economics and Business Administration. [Downloadable!]
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  2. Filacek, Jan & Horvath, Roman & Skorepa, Michal, 2006. "Monetary Policy before Euro Adoption: Challenges for EU New Members," MPRA Paper 879, University Library of Munich, Germany. [Downloadable!]
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  3. Jarko Fidrmuc & Roman Horváth, 2006. "Credibility of Exchange Rate Policies in Selected EU New Members: Evidence from High Frequency Data," Working Papers IES 2006/28, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, revised Oct 2006. [Downloadable!]
  4. John Lewis, 2007. "Hitting and Hoping? Meeting the Exchange Rate and Inflation Criteria during a Period of Nominal Convergence," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
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