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

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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 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.

Suggested Citation

  • Paul De 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
    DOI: 10.1111/j.0023-5962.2005.00301.x
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    References listed on IDEAS

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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.
    2. Paul De Grauwe & Gunther Schnabl, 2004. "Exchange Rate Regimes and Macroeconomic Stability in Central and Eastern Europe," International Finance 0404011, University Library of Munich, Germany.
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