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Nominal versus Real Convergence with Respect to EMU Accession - EMU Entry Scenarios for the New Member States

  • Gunther Schnabl

    (Tübingen University)

  • Paul De Grauwe

    (Catholic University Leuven)

This paper explores the conflict of real and monetary convergence during the EMU run-up of the Central and Eastern European new EU member states. Based on a Balassa-Samuelson model of productivity driven inflation, it finds a high probability of higher inflation in the new member states. 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 above the ERM2 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 might choose fiscal contraction as a solution, which will require a high degree of fiscal flexibility and thereby decisive

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Paper provided by EconWPA in its series International Finance with number 0403008.

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Length: 27 pages
Date of creation: 15 Mar 2004
Date of revision: 05 Jul 2004
Handle: RePEc:wpa:wuwpif:0403008
Note: Type of Document - pdf; pages: 27
Contact details of provider: Web page: http://econwpa.repec.org

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