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

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  • Paul Grauwe
  • Gunther Schnabl

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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  • Paul Grauwe & Gunther Schnabl, 2005. "Nominal Versus Real Convergence - EMU Entry Scenarios for the New Member States," Kyklos, Wiley Blackwell, vol. 58(4), pages 537-555, November.
  • Handle: RePEc:bla:kyklos:v:58:y:2005:i:4:p:537-555
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    1. Dubravko Mihaljek & Marc Klau, 2003. "The Balassa-Samuelson effect in central Europe: a disaggregated analysis," BIS Working Papers 143, Bank for International Settlements.
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    Cited by:

    1. Andreas Hoffmann, 2010. "An Overinvestment Cycle In Central And Eastern Europe?," Metroeconomica, Wiley Blackwell, vol. 61(4), pages 711-734, November.
    2. Václav Žďárek, 2008. "Some thoughts on nominal convergence, its drivers and determinants for the new eu member states preparing the euro adoption," Prague Economic Papers, University of Economics, Prague, vol. 2008(4), pages 291-318.
    3. Fidrmuc, Jarko & Horváth, Roman, 2008. "Volatility of exchange rates in selected new EU members: Evidence from daily data," Economic Systems, Elsevier, vol. 32(1), pages 103-118, March.
    4. Hubert Gabrisch & Lucjan T. Orlowski, 2010. "Interest Rate Convergence in Euro-Candidate Countries: Volatility Dynamics of Sovereign Bond Yields," Emerging Markets Finance and Trade, M.E. Sharpe, Inc., vol. 46(6), pages 69-85, November.
    5. 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.
    6. Michael Frömmel, 2010. "Volatility Regimes in Central and Eastern European Countries’ Exchange Rates," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 60(1), pages 2-21, February.
    7. John Lewis, 2011. "How has the Financial Crisis Affected the Eurozone Accession Outlook in Central and Eastern Europe?," Chapters,in: The Economic Crisis and European Integration, chapter 11 Edward Elgar Publishing.
    8. Gabrisch, Hurbert & Orlowski, Lucjan, 2009. "Interest Rate Convergence in the Euro-Candidate Countries: Volatility Dynamics of Sovereign Bond Yields," Working Papers 2009001, Sacred Heart University, John F. Welch College of Business.
    9. Giulio Palomba & Emma Sarno & Alberto Zazzaro, 2009. "Testing similarities of short-run inflation dynamics among EU-25 countries after the Euro," Empirical Economics, Springer, vol. 37(2), pages 231-270, October.
    10. Levy Yeyati, Eduardo & Sturzenegger, Federico, 2010. "Monetary and Exchange Rate Policies," Handbook of Development Economics, Elsevier.
    11. Lewis, John, 2009. "Hitting and hoping?: Meeting the exchange rate and inflation criteria during a period of nominal convergence," European Journal of Political Economy, Elsevier, vol. 25(4), pages 508-524, December.
    12. Orlowski, Lucjan T., 2008. "Relative inflation-forecast as monetary policy target for convergence to the euro," Journal of Policy Modeling, Elsevier, vol. 30(6), pages 1061-1081.
    13. repec:zbw:rwirep:0147 is not listed on IDEAS
    14. Kowalski, Tadeusz & Shachmurove, Yochanan, 2014. "The reaction of the U.S. and the European Monetary Union to recent global financial crises," Global Finance Journal, Elsevier, vol. 25(1), pages 27-47.
    15. 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.
    16. Kowalski, Tadeusz, 2013. "Globalization and Transformation in Central European Countries: The Case of Poland," MPRA Paper 59306, University Library of Munich, Germany.
    17. Ayala, Astrid & Blazsek, Szabolcs, 2013. "Structural breaks in public finances in Central and Eastern European countries," Economic Systems, Elsevier, vol. 37(1), pages 45-60.
    18. Juraj Antal & Jan Filáček & Jan Frait & Roman Horvath & Viktor Kotlán & Michal Skořepa, 2009. "Monetary Policy Strategies before Euro Adoption: The Art of Chasing Many Rabbits," Czech Economic Review, Charles University Prague, Faculty of Social Sciences, Institute of Economic Studies, vol. 3(2), pages 176-198, July.
    19. Orlowski, Lucjan T. & Rybinski, Krzysztof, 2006. "Implications of ERM2 for Poland's monetary policy," Economic Systems, Elsevier, vol. 30(4), pages 346-365, December.
    20. Ansgar Belke & Gunther Schnabl & Holger Zemanek, 2009. "Real Convergence, Capital Flows, and Competitiveness in Central and Eastern Europe," Ruhr Economic Papers 0147, Rheinisch-Westfälisches Institut für Wirtschaftsforschung, Ruhr-Universität Bochum, Universität Dortmund, Universität Duisburg-Essen.
    21. Ádám Török, 2007. "Industrial Policy in the New Member Countries of the European Union: A Survey of Patterns and Initiatives Since 1990," Journal of Industry, Competition and Trade, Springer, vol. 7(3), pages 255-271, December.
    22. Mirdala, Rajmund & Ruščáková, Anna, 2015. "On Origins and Implications of the Sovereign Debt Crisis in the Euro Area," MPRA Paper 68859, University Library of Munich, Germany.
    23. Hiranya Nath & Kiril Tochkov, 2013. "Relative inflation dynamics in the new EU member countries of Central and Eastern Europe," Empirical Economics, Springer, vol. 45(1), pages 1-22, August.
    24. Michal SKOREPA, 2013. "Troubles in the Euro Area Periphery: The View through the Lens of a Simple Convergence-Sensitive Optimum Currency Area Index," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 63(2), pages 129-151, May.
    25. Gabrisch, Hubert & Orlowski, Lucjan T., 2009. "A Dynamic Approach to Interest Rate Convergence in Selected Euro-candidate Countries," IWH Discussion Papers 10/2009, Halle Institute for Economic Research (IWH).

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