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Nominal versus Real Convergence with Respect to EMU. How to Cope with the Balassa-Samuelson Dilemma", mimeo

By Paul De Grauwe and Gunther Schnabl

Abstract

This paper explores the conflict of real and monetary convergence during the EMU run-up of the future Central and Eastern European (CEE) EU member states. Based on a Balassa-Samuelson model of productivity driven inflation, it compares the policy options which might make the compliance possible, i.e., fiscal tightening and nominal appreciation within the ERM2 band. Nominal appreciation within ERM2 seems the better option to achieve the compliance with the Maastricht criteria as no discretionary government intervention is necessary and losses in terms of real growth are less. Having once opted for nominal appreciation within ERM2 the Irish model seems the best choice. By fixing the ERM2 entry rate as the ERM2 central rate, a high degree of flexibility is provided in coping with erratic short-term capital inflows. When decisions about possible revaluation prior to the final fixing of the EMU entry rate are made, the CEE countries have to weigh the positive competitiveness effect of deprecation against the danger of additional inflationary pressure in the post-entry period. Despite the merits of nominal appreciation, countries committed to hard euro pegs might choose fiscal contraction as the second best solution

Topics: union, Central and Eastern Europe
Year: 2003
OAI identifier: oai:CiteSeerX.psu:10.1.1.195.1444
Provided by: CiteSeerX
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