Abstract
This paper studies the relationship between real convergence in the euro area and macroeconomic imbalances. It compares the main features of convergence within the euro area with other EU and non-EU country groups, looking at both ‘sigma’ and ‘beta’ convergence in output and total factor productivity. Expected convergence paths for euro area countries are estimated using growth regressions run on a large panel of advanced and emerging market economies and compared to actual growth. The findings support the view that EU and euro area countries display similar convergence patterns to those of other country groups, while the group of countries that adopted the euro first exhibit relatively weak convergence since before the financial crisis. Such differences could be partly linked to relatively low dispersion in per capita incomes across this country group, although lack of convergence is also largely due to persisting differences in total factor productivity performance. The findings also suggest that macroeconomic imbalances accumulated in the pre-crisis period such as high private and government debt and strong growth in the non-tradable sector have been associated with lower convergence, particularly for euro area countries.
Highlights
This paper studies the relationship between real convergence in the euro area and macroeconomic imbalances
There is instead no evidence of convergence for the EA11, and total factor productivity (TFP) appears to diverge over the period following the financial crisis
What factors could have been responsible for the lack of convergence across the euro area? Did macroeconomic imbalances play a role? To answer these questions, a first necessary step is to construct a measure of the ‘convergence gaps’, namely quantify the gap between actual growth and the growth paths to steady-state growth rates expected on the basis of the relevant characteristics of countries, i.e. the initial level of output per capita and all other conditioning factors
Summary
This paper studies the relationship between real convergence in the euro area and macroeconomic imbalances. In line with the optimal currency area (OCA) theory (Mundell, 1961), countries ought to be sufficiently similar and integrated to reduce the likelihood of asymmetric shocks and have flexible product and labour markets to lower the costs of adjusting in the absence of nominal exchange rates In this respect, the academic debate in the period preceding the EMU was focused on real rather than on nominal convergence, emphasising the structural transformations along the convergence process that would reduce differences in economic institutions, the occurrence of asymmetric shocks and adjustment costs in a monetary union. In anticipation of a stable currency and no redenomination risks, both the mean and the variance of ten-year government bond rates across 12 euro area (EA) countries dropped significantly between 1994 and 1997 (see Figure 1) This process lasted for about a decade, but was interrupted by the European sovereign debt crisis of 2010-2012, during which this variance spiked to levels last seen only prior to the 1990s. ‘Sudden stops’ in current accounts led to a major contraction
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