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Growth and Economic Policy: Are There Speed Limits to Real Convergence?

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  • Istv�n P. Sz�kely
  • Max Watson

Abstract

Real convergence in the recently acceded EU member states (RAMS) is taking place in a new environment, with important implications for convergence and vulnerabilities. Financial liberalization can increase temporary imbalances, while financial integration provides the necessary external finance to support the larger current account deficits involved. Thus, periods during which relative prices are distorted and resources are not reallocated to reach a new equilibrium can be lengthened. When prices are sticky, the exchange rate regime matters in the short run: a fixed exchange rate regime generates a larger current account deficit than a flexible exchange rate regime. That is, the extent of vulnerability to adjustment risk will depend on several factors, and trade-offs between these, including price stickiness, the extent of unhedged balance sheet exposures, and the degree of nominal flexibility afforded by the exchange rate regime. Financial liberalization and integration may also lead to sizable changes in th composition of final demand, and through this, considerable movements in the equilibrium real exchange rate. It may therefore be a challenging task for policymakers to achieve fast and steady nominal convergence in certain phases of convergence in this new environment. The paper discusses the challenges policymakers in RAMS face and the policies that can make the convergence process faster and smoother.

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Bibliographic Info

Paper provided by Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission in its series European Economy - Economic Papers with number 294.

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Length: 25 pages
Date of creation: Dec 2007
Date of revision:
Handle: RePEc:euf:ecopap:0294

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Keywords: real and financial convergence; financial integration; recently acceded EU member states; Sz�kely; Watson;

References

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  4. Daniel Leigh & Abdul Abiad & Ashoka Mody, 2007. "International Finance and Income Convergence," IMF Working Papers 07/64, International Monetary Fund.
  5. Olivier Blanchard, 2007. "Current Account Deficits in Rich Countries," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 54(2), pages 127-158, June.
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  7. M. Ayhan Kose & Eswar Prasad & Kenneth Rogoff & Shang-Jin Wei, 2009. "Financial Globalization: A Reappraisal," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 56(2), pages 143-197, June.
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  9. Philippe Aghion & Ioana Marinescu, 2008. "Cyclical Budgetary Policy and Economic Growth: What Do We Learn from OECD Panel Data?," NBER Chapters, in: NBER Macroeconomics Annual 2007, Volume 22, pages 251-278 National Bureau of Economic Research, Inc.
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Cited by:
  1. Regling, Klaus & Deroose, Servaas & Felke, Reinhard & Kutos, Paul, 2010. "The Euro After Its First Decade: Weathering the Financial Storm and Enlarging the Euro Area," ADBI Working Papers 205, Asian Development Bank Institute.
  2. Klaus Regling & Servaas Deroose & Reinhard Felke & Paul Kutos, 2010. "The Euro After Its First Decade : Weathering the Financial Storm and Enlarging the Euro Area," Governance Working Papers 22817, East Asian Bureau of Economic Research.
  3. Ram Upendra Das, 2010. "Imperatives of Regional Economic Integration in Asia in the Context of Developmental Asymmetries: Some Policy Suggestions," Working Papers id:3037, eSocialSciences.
  4. Klaus Regling & Max Watson, 2008. "Financial Markets in the Euro Area: Realising the Full Benefits of Integration," Cyprus Economic Policy Review, University of Cyprus, Economics Research Centre, vol. 2(1), pages 11-24, June.

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