Income Convergence and Inflation in Central and Eastern Europe

Abstract

This study investigates the process of price convergence in the ten new EU countries of Central and Eastern Europe. The analyses are based on panel data from 1995 to 2008 of the common currency price relative to the EU15 average. The lagged income level exhibits little explanatory power toward relative inflation, but the lagged price level has some explanatory power. In the long term, the relative income and price levels are closely correlated, implying concurrent real and nominal convergence. Deviations from the long-term relation between income and price levels are gradually decreased by changes in relative inflation and gross domestic product growth, but the process of convergence appears to be rather slow. In the short term, the capital inflows associated with current account deficits put substantial upward pressure on relative price inflation, but the Balassa-Samuelson effect appears to be subdued.