How far from the Euro Area? Measuring convergence of inflation rates in Eastern Europe

Bettina Becker,Stephen G Hall

doi:10.1016/j.econmod.2009.01.016

Abstract

We present a common factor framework of convergence which we implement using principal components analysis. We apply this technique to a dataset of monthly inflation rates of EMU and the Eastern European New Member Countries (NMC) over 1996–2007. In the earlier years, the NMC rates moved independently from an average of the three best performing countries over the past twelve months, while they moved somewhat closer in line with them in the later years. Looking at the sample of the EMU and NMC countries as a whole, there is evidence of a formation of convergence clubs across the two groups.

Highlights

Convergence has been a popular theme in applied economics since the seminal papers of Barro (1991) and Barro and Sala-i-Martin (1992)
We have shown how this is in many ways a more natural way to consider the problem than those conventionally used. We have applied these ideas to a dataset of monthly harmonised consumer price inflation rates of the European Monetary Union (EMU) countries, the New Member Countries (NMC) countries and three European Union (EU) candidate countries over the period 1996-2007
We have considered groups between them, and convergence of the NMC countries to the Euro Area aggregate and to a measure of inflation rates of the three best performing countries in the past twelve months, as a close proxy to the Maastricht convergence criterion

Summary

Introduction

Convergence has been a popular theme in applied economics since the seminal papers of Barro (1991) and Barro and Sala-i-Martin (1992). In this paper we build on our earlier work (Becker and Hall, 2009) in considering some of the standard definitions of convergence and suggesting an alternative way to think about convergence based on a common factor framework which we implement using principal components analysis. We apply these ideas to a dataset of monthly inflation rates of the EMU countries, the NMC countries and three EU candidate countries (as of pre-2007) over the period 1996-2007.

Defining Convergence

Empirical Application

Gradual Convergence Patterns of EMU Inflation Rates

Gradual Convergence Patterns of the New Member Countries’ Inflation Rates

Conclusion