Nominal Convergence Research Articles

Eu funds for New Member States from a macroeconomic perspective

New Member States (NMS) are receiving large and increasing volumes of EU transfers that affect the process of convergence between the EU economies. Growth benefits from EU funds, related to a real convergence, depend strongly on the absorption and utilisation of the transfers, with the priority to finance investments. EU transfers bring opportunities as well as challenges for the process of nominal convergence between NMS and the EMU economies. The intervention highlights the argument that macroeconomic policies oriented towards a sustainable growth, close to its potential, help new members maximise benefits from EU funds.

Sacrifice ratio dispersion within the Euro Zone: what can be learned about implementing a single monetary policy?

This article focuses on the comparison of sacrifice ratios as an indicator for structural dispersion within the euro area over the period 1972–2003. Estimates of the sacrifice ratio, defined as the cumulative output cost arising from permanent inflation reduction, are obtained using structural VAR models. Results from sub‐period analysis as well as 10‐year‐period rolling estimates lead to two main conclusions. First, empirical evidence displays a recent increase in the average sacrifice ratio, which can be linked to the simultaneous decrease in the average inflation rate: this negative relationship between the initial level of inflation and the cost of disinflation can be seen as a justification for the choice of an inflation objective close to 2% for the European Central Bank (ECB) rather than a target of perfect price stability, potentially very damaging. Second, we cannot provide evidence of any reduction in European sacrifice ratio dispersion, which would suggest that the nominal convergence triggered by the Maastricht Treaty did not involve a true reduction of structural differences. It is likely to be a problem in the stance of a single monetary policy, because structural differences imply asymmetric responses of real national economies to the same monetary impulse.

Long-term Growth Perspectives and Economic Convergence of CEE and SEE Countries

The paper first investigates the main drivers of economic growth and real convergence in CEE and SEE Countries. In the theoretical framework provided by the growth-accounting approach, both are shown to be driven by capital accumulation and total factor productivity changes, with the latter making however a major contribution. The nominal convergence path towards the Eurozone is then analysed. Despite considerable results obtained in the last decade, most EU new members are still found to face severe challenges in the process of converging towards Maastricht criteria. The need to reconcile exchange rate stability with inflation convergence is in particular seen to be at the heart of their de facto decision to delay the EMU entry date until a higher degree of real convergence will have been achieved.

Is there a connection between monetary unification and real economic integration? Evidence from regime-switching stationarity tests

We investigate the extent of real convergence among G7 economies in terms of long-run real interest parity. A novel approach is applied where unit-root tests of real interest differentials are embedded within a Markov regime-switching framework. Whereas standard univariate unit-root tests provide little support for parity, we find real convergence is present after allowing for regime switches in real interest misalignments. However, differentials across members of the euro zone are likely to exhibit greater persistence despite nominal convergence. It is non-sequitur to infer from monetary unification that nominal convergence is necessarily conducive to real interest realignments or preventive of misalignments.

Entry rates and the risks of misalignment in the EU8

New member states will join the EMU in the coming years. Setting the central parity at which they will join has been and will be a challenging task, as there is a considerable amount of uncertainty, both from a theoretical and an empirical perspective, surrounding the determination of the optimal exchange rate. Given the probable difficulty in evaluating the equilibrium rate it is thus advisable to focus on the effects of a misalignment of the entry rate for the economy, as it has implications for countries’ real and nominal convergence. An overvalued exchange rate would have an adverse impact on a country's competitiveness and its growth, while an undervalued currency would contribute to an overheating of the economy and an excessive inflation. The objective of this paper is to better understand the role of the entry rates for short run inflation and GDP developments and their implications for the inflation criterion and the real convergence process. Having estimated equilibrium exchange rates for eight out of ten countries that entered the EU in May 2004: Czech Republic, Estonia, Hungary, Lithuania, Latvia, Poland, Slovenia and Slovakia we conduct simulations showing what their adjustments to equilibrium would be if their entry rates deviated from the optimal ones.

Uncertainty and the Price of Risk in a Nominal Convergence Process

In this paper we decompose nominal interest rates into real risk-free rates, inflation expectations and risk premia using an affine model that takes as factors the observed inflation rate and the parameters generated in the zero yield curve estimation. We apply this model to the Spanish economy during the 90s, which is an especially challenging exercise given the nominal convergence towards the European Monetary Union (EMU) then under way. The methodology seems to be suitable for other countries currently involved in convergence towards EMU. The evidence indicates that inflation expectations and risk premia account for most of the observed variation in nominal rates, while real risk-free interest rates show a reduction during this period lower than that suggested by other approaches.

Some thoughts on nominal convergence, its drivers and determinants for the new eu member states preparing the euro adoption

The article analyses the process of nominal convergence of the new EU member states (NMS) with particular attention paid to some applied and theoretical aspects, which may have impact on the process of the euro adoption. Chapter two addresses selected theoretical and methodological issues connected with the International Comparison Project (ICP). It discusses determinants and influences affecting price level convergence and some issues that have set off new trends, such as the globalization or process of the on-going European integration. This chapter also presents a brief summary of the main trends of price convergence observed by focusing on changes of comparative price levels (CPL) for various disaggregated items of GDP. It also deals with potential issues and problems arising in this context. Chapter three is aimed at an empirical verification of price convergence and at a search for main driving factors using data for the NMS and the old EU member states over 11 years (1995-2006). There are some differences in results depending on the applied econometric method. The most important determinants of price level are GDP and population, the openness and public finance's indicators are not significant. The last section summarises the main findings.

Wage, Price and Unemployment Dynamics in the Spanish Transition to Emu Membership

This paper provides an empirical investigation of the wage, price and unemployment dynamics that have taken place in Spain during the last two decades. The aim of this paper is to shed light on the impact of the European economic integration process on Spanish labour market and the convergence to a European level of prosperity. We find some important lessons to be learnt from the Spanish experience that should be relevant for the new member states. Second, before fixing the real exchange rate it seems crucial that it is on its sustainable (competitive) purchasing power parity level. First, high competitiveness in the tradable sector seems crucial for the real and nominal convergence to be successful. The increase in consumption wages and consumer prices as a result of the Balassa-Samuelson effect should not be allowed to exceed the improvement in productivity. Second, before fixing the real exchange rate it seems crucial that it is on its sustainable (competitive) purchasing power parity level. Third, there does not seem to be a short-cut to a European level of standard of living: the path to sustainable prosperity seems to follow the path of productivity improvement. Forth, excessive real wage increases seem to lead to increasing unemployment, slowdown in productivity growth, higher interest rates, and loss of competitiveness. On the other hand, the access to the European market and the possibility of increased export demand is likely to speed up the convergence process as long as competitiveness is not eroded by excess wage increases.

The Impact of Poland's EU Accession on its Economy

The paper briefly discusses the main economic developments in Poland since its accession to the EU in May 2004 and sees how they relate to the regulatory environment and policies which the EU imposes on the member states. The paper starts with a brief description of principles, legislation and policies adopted in the EU, which influence the decisions made by the government, as well as entrepreneurs, investors, companies and workers. Next it discusses outcomes that were anticipated to occur as a result of the 2004 accession. Economic developments in Poland in two years of EU membership are presented in the last section. It starts with the macroeconomic performance, including economic growth and nominal convergence. The effects of Poland's participation in the single market on Polish trade (goods and services flows), capital flows (foreign direct investments - FDI), and labor flows (and specifically migration to the EU-15) are also discussed. The size and destination of EU funds committed to Poland are presented. The final paragraph confronts the factual results of the economic processes, highlighting the public's perception of Poland's accession and their assessment of the outcomes both for their country and for themselves as individuals. Even though the paper concerns the recent period of 2004-2006 there are frequent references to developments that took place in Poland in the pre-accession period. This is because the country's integration into the EU economy was a gradual and lengthy process which had formally been initiated in December 16, 1991 when Poland and the EU signed the Europe Agreement.

How is real convergence driving nominal convergence in the new EU Member States?

We evaluate the empirical relevance of real convergence on the process of nominal convergence for the new EU Member States. We focus our discussion on two main channels: productivity growth and increased trade openness. Productivity growth can have a positive effect on price levels via the Balassa–Samuelson effect, whereas increased openness leads to reductions in mark-ups and costs and therefore can have a negative impact on prices. We empirically assess their relevance using a Structural VAR model to which we applied a model reduction algorithm. Our findings show that, in general, openness has had a negative impact and productivity growth a positive one on price level convergence with respect to the euro area.

Meeting the Challenge of Monetary Union: Lessons from the Finnish Experience

We study lessons from the experience of Finland in meeting the challenges of joining the euro area at its outset and its subsequent economic success. Traditional optimum currency area theory is too limited a framework for judging the experience in qualifying and membership.Five main factors have an influence on the experience: asymmetric shocks in the country joining the area; the prior conditions, particularly the real exchange rate; structural flexibility of the country; degree of economic, institutional and regulatory integration; attractiveness of the outside option. The main lessons to be learned from the Finnish experience are: the importance of timing; the fact that targeting low inflation and prudent fiscal policy can deliver nominal convergence; the relative merits of prior convergence of economic structures, policies and institutions and favourable starting conditions, as opposed to imminent membership itself changing structural behaviour and providing the discipline for change.

Credit booms, monetary integration and the new neoclassical synthesis

Credit to the private sector has risen rapidly in many new Central and Eastern European EU Member States (nMS) in recent years. The lending boom has recently been particularly strong in the segment of loans to households, primarily mortgage-based housing loans, and in those countries that operate currency boards or other forms of hard pegs. The main aim of this paper is to propose a conceptual framework to analyze the observed developments with a view to exploring some policy implications at a stage in which these countries are preparing for their prospective integration with the euro area. To achieve this, we first use a stylized new neoclassical synthesis (NNS) framework, which has recently been advanced by Goodfriend [Goodfriend, M., 2002. Monetary policy in the new neoclassical synthesis: A primer, Federal Reserve Bank of Richmond, July.] and Goodfriend and King [Goodfriend, M., King, R., 2001. The case for price stability. NBER Working Paper 8423]. We then discuss the implications of the NNS model for credit dynamics and ensuing monetary policy challenges. Specifically, we emphasize consumption smoothing as an important channel of the observed credit expansion and we show how it is related to and how it affects the monetary policy making in MS. In doing so, we place our discussion in the context of the monetary integration process in general and the nominal convergence process in particular.

From One Country, Two Systems to Monetary Integration?

The Hong Kong dollar has been pegged to the U.S. dollar since 1983. Recently, the rapid economic integration between Mainland China and Hong Kong has raised concern about the continuing optimality of the peg. Officially, the Hong Kong Special Adminstrative Region (HKSAR) is under the framework of “one country, two systems” and “one country, two currencies”. Hence monetary integration was never in the pipeline. However, is the existence of separate currencies consistent with the fast changing economic reality? Would a re-peg with the Renminbi, the Chinese currency, or even a monetary union with the Mainland, be possible options, particularly if the Renminbi becomes fully convertible some time in the future? If so, what are the preconditions for the options? What needs to be done to prepare for them? This paper addresses these interesting questions by going through the complicated issues of trade, real versus nominal convergence, risk sharing as well as labour mobility. It emerges that the status quo is optimal in the foreseeable future.

Exchange Rate Regimes and Convergence Criteria for Accession Economies: The Case of Macedonia and Croatia

The paper assesses the nominal convergence of Macedonia and Croatia towards the EU. As the two countries are in a process of European integration, both economies should converge to the EU economy, so that the accession to be smoother. One channel for faster nominal convergence is pegging the national currency to the euro. Macedonia does this for more than a decade (previously to the DM), whereas Croatia maintains managed float. The assessment is focused on the question how different monetary strategies achieve the nominal convergence in terms of the fulfilment of the Maastricht convergence criteria.

Exchange rate strategies towards the euro-zone for new EU member states with currency boards

The paper investigates the transition of the new EU countries with a currency board arrangement (CBA) to the euro-zone. The arguments for and against retaining a CBA while participating in the exchange rate mechanism of the EU (ERMII) are discussed. Then, we show in the framework of a signalling model that abandoning a CBA and allowing the exchange rate to fluctuate within the bands of ERMII can signal to markets the sustainability of nominal convergence and, hence, diminish uncertainty in the pre-accession period and increase the probability of being accepted into the euro-zone.

Lessons from Nominal Convergence in Slovenia

Two years after joining the ERM2 mechanism Slovenia had fulfilled the legal requirements for joining EMU as well as the Maastricht criteria. This article analyses how the path to EMU affected Slovenian nominal convergence, more specifically yield spread movements for standardised maturities. For that purpose daily Slovenian yield curves were estimated in the period after introduction of the OTC–DVP market. The results show that yield spreads between the Slovenian and the generic EMU government yield curves decreased significantly at the beginning of March 2006 when Slovenia requested individual appraisal of EMU criteria fulfilment. Yield spreads decreased further in July 2006 when the definite fixed exchange rate was set.

Reálná a nominální konvergence v zemích středoevropské pětky

This paper deals with the narrowing the income gap between the Central and East European New Member States (NMS-5) and the EU-25 and with the trade-off between the real and nominal convergence. The methodology is based on international standards enabling comparisons of macroeconomic indicators, especially of GDP per capita in purchasing power parity and alternative indicators of real gross domestic income, which comprises gains or losses from the terms of trade changes. In the chapter 1 the changes in catching-up and in the position of the NMS-5 economy within the framework of EU-25 are analysed. Chapter 2 deals with the trade-off between the real and nominal convergence. The regression analysis of the comparative price and wage level in relation to the economic level reveals deviations from the theoretical values, especially in the Czech Republic. The unit labour cost's level comparisons examine the cost/price competitiveness. The perspective of real convergence is analysed in the conclusion.

EU Enlargement and the EMU

This paper investigates empirically the extent to which the ten new EU countries are ready to join the European Monetary Union (EMU). Using France and Germany as a benchmark, we assess the prospects of successful EMU participation based on common trends analysis of the nominal convergence criteria as well as on real exchange rates and real per capita GDPs. The empirical results indicate that the new EU countries are partially ready to join the eurozone, and need further adjustments in their government policies to be fully prepared for joining the EMU.

Competitiveness and Modernisation of Public Finances

The most important strategic tasks of Hungarian economic policy are to complete the process of European integration, to build up the appropriate institutional and social capacities and to harmonise real and nominal convergence. This article discusses a theoretical framework for modernisation and how it could be adapted to the Hungarian public sector. Several action scenarios are discussed, but any reforms should aim to rethink the role of the state and improve competitiveness while maintaining social cohesion.

Inside the European Union: A Macroeconomic Diagnosis of Romania At the Moment of Integration

Romania joined the European Union after many years of uneven efforts and uncertainty about the effective date of integration. In this paper we try to evaluate the economic situation of Romania at the moment of joining the European Union. We try to identify the main macroeconomic developments over the last years prior to integration, which will show the extent to which the country has prepared this integration from an economic point of view. This diagnosis will serve as a basis for inquiring about the possible future consequences of membership, as well as about the perspectives of the Romanian economy after the integration. The regional characteristics in terms of development are equally analyzed. Economic growth has resumed since 2000, but its drivers have gradually shifted from investment towards private consumption, while the level of development is still significantly lower than the EU average. Most of Romania's social indicators lag behind EU ones. Persistent macroeconomic imbalances have slowed down the real and nominal convergence process. The economy is still affected by low competitiveness, incomplete restructuring, modest productivity in agriculture, a high level of employment in subsistence agriculture and slow disinflation.