Exchange rate regime shift and price patterns

Abstract

PurposeThe financial crisis starting in 2008 made many European countries opt for a change of exchange rate regime. The choice of price measure as an entry requirement to the European Economic and Monetary Union (EMU) and as input in the monetary policy decision process re‐appeared as an important political and research issue. This paper aims to argue that, considering the importance of producer prices in international competition, their role is underplayed by policy makers and researchers.Design/methodology/approachProducer prices are analyzed in the transition from national exchange‐rate regimes to the EMU for 13 two‐digit manufacturing sectors in the first 11 countries to adopt the Euro.FindingsIt was found that significant price convergence before 1993‐1998, but no or modest evidence of convergence after 1998‐2005 when the Euro was introduced. This pattern is partly different from what prior studies have found for consumer prices, and is consistent with the change of exchange rate regime to a monetary union anchoring inflation rates. A conditionalβ‐convergence analysis reveals effective exchange‐rate changes and differences in cyclicality as important determinants of price convergence, suggesting that import of inflation is an important determinant of price developments in the EMU.Research limitations/implicationsThe paper concludes that considering the role of producer prices and their deviating pattern from consumer prices, producer prices are underplayed in the research and deserve more attention. It is argued that increased attention to producer prices is warranted.Practical implicationsFocusing monetary policymaking on consumer prices alone appears inefficient. Rather, then, support for the trade‐off approach in monetary policy‐making is supported.Social implicationsIn considering different solutions to the financial crisis, increasing attention should be paid to the development of producer prices.Originality/valueThis is the first study to focus on producer prices in the research on the transition from a national exchange rate regime to a membership of a monetary union.