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Nominal versus Real Convergence with Respect to EMU Accession.How to Cope with the Balassa-Samuelson Dilemma

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  • Paul de Grauwe
  • Gunther Schnabl

Abstract

This paper explores the conflict of real and monetary convergence during the EMU run-up of the future Central and Eastern European (CEE) EU member states. Based on a Balassa-Samuelson model of productivity driven inflation, it compares the policy options which might 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 less. Having once opted for nominal appreciation within ERM2 by fixing the ERM2 entry rate as the ERM2 central rate (Irish model), a high degree of flexibility is provided in coping with erratic short-term capital inflows. Setting the ERM2 entry rate below or above the ERM2 central rate (Greek model) implies a clear exchange rate path within ERM2 and thereby less exchange rate volatility. But the Greek model also requires accurate information about the future exchange rate path and strict fulfilment of the Maastricht criteria within the projected time frame. Despite the merits of nominal appreciation, countries committed to hard euro pegs might choose fiscal contraction as the second best solution.

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Bibliographic Info

Paper provided by European University Institute (EUI), Robert Schuman Centre of Advanced Studies (RSCAS) in its series EUI-RSCAS Working Papers with number 20.

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Date of creation: 15 Oct 2004
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Handle: RePEc:erp:euirsc:p0137

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Keywords: Euro; EMU; EU-East-Central Europe; enlargement;

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References

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Citations

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Cited by:
  1. Lucjan T Orlowski, 2005. "Monetary Policy Adjustments on the Final Passage towards the Euro," Macroeconomics 0503022, EconWPA.
  2. Schnabl, Gunther, 2003. "De jure versus de facto: Exchange rate stabilization in Central and Eastern Europe," Tübinger Diskussionsbeiträge 269, University of Tübingen, School of Business and Economics.
  3. Lucjan T Orlowski, 2005. "Exchange Rate Risk and Convergence to the Euro," Macroeconomics 0501034, EconWPA.
  4. Kocenda, Evzen & Kutan, Ali M. & Yigit, Taner M., 2006. "Pilgrims to the Eurozone: How far, how fast?," Economic Systems, Elsevier, vol. 30(4), pages 311-327, December.
  5. Aurel Iancu, 2008. "Nominal Convergence," Review of Economic and Business Studies, Alexandru Ioan Cuza University, Faculty of Economics and Business Administration, issue 2, pages 53-73, November.
  6. Pelinescu, Elena & Caraiani, Petre, 2006. "Does the Inflation Targeting Have a Positive Role upon the Convergence of the Inflation Rate?," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 3(3), pages 39-50, September.
  7. Iancu, Aurel, 2010. "Transition, Integration And Convergence - The Case Of Romania -," Working Papers of National Institute of Economic Research 101222, National Institute of Economic Research.

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