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EMU enlargement and convergence of price levels: Lessons from the German reunification

  • Philipp Maier

    (De Nederlandsche Bank)

  • Paul Cavelaars

    (De Nederlandsche Bank)

We analyse the possible impact of EMU enlargement on inflation rates in the accession countries. Using a simple theoretical model we show that the optimal path price adjustments should be asymmetric, i.e. occuring mostly in the candidate countries. Using data from the German reunification we examine how price level convergence could come about. These findings are applied to the enlargement EMU: our findings indicate that (trend) inflation rates in the EMU candidate countries are likely to increase sharply, whereas the impact on the current euro area likely to be small, albeit not negligible. Our results support the need to allow some flexibility in the exchange rate arrangements with the candidate countries facilitate gradual price level convergence prior to EMU enlargement.

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Paper provided by EconWPA in its series Macroeconomics with number 0306016.

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Date of creation: 23 Jun 2003
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Handle: RePEc:wpa:wuwpma:0306016
Note: Type of Document - PDF file; prepared on Windows
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  1. Froot, Kenneth A. & Rogoff, Kenneth, 1995. "Perspectives on PPP and long-run real exchange rates," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 32, pages 1647-1688 Elsevier.
  2. Jean Imbs & Haroon Mumtaz & Morten O. Ravn & Helene Rey, 2003. "PPP Strikes Back: Aggregation and the Real Exchange Rate," IEHAS Discussion Papers 0307, Institute of Economics, Centre for Economic and Regional Studies, Hungarian Academy of Sciences.
  3. Stephen G. Cecchetti & Nelson C. Mark & Robert J. Sonora, 2000. "Price Level Convergence Among United States Cities: Lessons for the European Central Bank," NBER Working Papers 7681, National Bureau of Economic Research, Inc.
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  9. Cohen, Daniel, 1997. "How Will the Euro behave?," CEPR Discussion Papers 1673, C.E.P.R. Discussion Papers.
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  11. Charles Engel & John H. Rogers, 1995. "How wide is the border?," Research Working Paper 95-09, Federal Reserve Bank of Kansas City.
  12. Charles Engel & John H. Rogers, 1999. "Deviations from Purchasing Power Parity:Causes and Welfare Costs," Discussion Papers in Economics at the University of Washington 0038, Department of Economics at the University of Washington.
  13. George A. Akerlof & William R. Dickens & George L. Perry, 1996. "The Macroeconomics of Low Inflation," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 1-76.
  14. Weber, Axel A. & Beck, Günter W., 2003. "Economic integration and the exchange rate regime: How damaging are currency crises?," CFS Working Paper Series 2001/13, Center for Financial Studies (CFS).
  15. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, vol. 12(3), pages 383-398, September.
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  17. Tomás Holub & Martin Cihák, 2001. "Convergence of Relative Prices and Inflation in Central and Eastern Europe," IMF Working Papers 01/124, International Monetary Fund.
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