The Link between Real and Nominal Convergence: The Case of the New EU Member States

Abstract

The new EU member states (EU-9)1 have made remarkable progress in past years in terms of real economic convergence with the euro area, that is, their standards of living and income levels have gradually increased towards those of the euro area. Still, the EU-9 countries display GDP per capita and price levels which are considerably below those of the euro area. Thus, the catching-up process will need to continue for some time. Income level convergence is usually accompanied by a continuous rise in the price level, which under certain conditions and also depending on the underlying exchange rate regime implies a higher inflation rate than in the euro area. Thus, the process of real convergence in the EU-9 is expected to continue playing an important role for future inflation developments in these countries. The interdependence of real and nominal convergence becomes particularly relevant, as the EU-9 are expected to join the euro area, for which inter alia the Maastricht inflation criterion needs to be fulfilled in a sustainable manner. From the perspective of the euro area, potentially higher inflation rates in the EU-9 countries would imply higher inflation differentials. Although the impact on the euro area inflation rate will most likely be limited due to the relatively low economic weight of the EU-9 compared with the euro area, this may nevertheless complicate the conduct and communication of a common monetary policy within an enlarged euro area.