Maastricht convergence and real convergence: European evidence from threshold and smooth transition regression models

Abstract

Maastricht-like convergence is well known to be prerequisite for monetary stability and the successful introduction of the euro. The 2% inflation target implicitly assumes that the relation between inflation and “economic performance” in general is nonlinear: there is almost no effect below this threshold, and significant negative effects above the threshold. In other words, the other pressing problem of the European Union (real convergence) depends to a large extent on Maastricht-like, nominal convergence. This paper attempts to test this “Maastricht proposition.” Two models are used, a threshold regression (where bootstrap methods have to be used to conduct inference), and a smooth transition model. The findings suggest that the threshold level of inflation is 4.3%, and there is significant evidence of nonlinearity in the inflation-growth nexus. There is negative relationship between inflation and growth for inflation rates above as well below the “threshold” level, but the effect above the “threshold” is almost three times as large. These results give support to EU anti-inflationary policies aiming at obtaining fiscal and monetary stability as a prerequisite for sustainable growth and real convergence.