Catching-up of new member countries and the real exchange rate appreciation László Halpern IEHAS, CEU, CEPR, WDI Ten Years of the Euro – Inspirations for the Czech Republic Prague, 25 November 2008

2 CPI based real effective exchange rate (1995 = 100)

3 Total economy unit labor costs based real effective exchange rate (1995 = 100)

4 Facts 1)Significant relative real appreciation of most NMS - Cyprus, Malta, Slovenia excepted - price - labour cost 2)No difference according to the growth rate

5 Interpretation 1)Initial undervaluation vs convergence 2)Explanatory factors a) BS b) PPP

6 BS 1)Definitions A) positive link bw income and price level B) low nontradable productivity C) higher growth of tradable productivity 2)Classification unchanged traded and nontraded sectors or activities 3)Endogenous tradability trade/transportation costs 4)Measurement

7 PPP 1)Sectors – composition effect 2)Products – aggregation level 3)Bar code data bw US and Canada large differences vanish fast small differences persist zero border-distance equivalent 4)Quality Price increase: inflation + quality?

8 Policy issues 1)Exchange rate regime inflation vs nominal appreciation 2)Maastricht criteria sustainability volatility 3)Real vs nominal convergence 4)Early vs late entry

9 Conclusions 1)Real appreciation is an equilibrium phenomenon of catching-up 2)Different explanations: BS, quality, pricing more micro evidence is needed 3)Real and nominal convergence includes price level convergence 4)Euro is a must 5)Maastricht inflation criterion is inappropriate 6)Countries should minimize the welfare loss of transition from national currency to euro

10 Balassa- Samuelson Effects Emerge: log Price Level versus log Per Capita Income

11 Balassa- Samuelson Effects Emerge: log Price Level versus log Per Capita Income

12 Balassa- Samuelson Effects Emerge: log Price Level versus log Per Capita Income

13 Regression coefficient of price level and per capita income in the cross section of countries present in 1950 (N=53)