Convergence of inflation and interest rates prior to EMU: An empirical analysis

Abstract

This paper assesses the rationale of inflation and interest rate convergence as a criterion for the passage to the final stage of EMU by analyzing the consequences of irrevocably fixing exchange rates while member states' performances are still diverging, on the basis of simulations conducted with the NIESR macroeconometric model (GEM). The results suggest that the fixing of exchange rates may produce spillover effects from high- to low-inflation countries under certain circumstances, and that if the Union's monetary authority seeks to counter these effects, the low-inflation countries may suffer a reduction of their output.