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Catching-up of new member countries and the real exchange rate appreciation

This paper by László Halpern discusses the real exchange rate appreciation among new EU member countries, looking at factors such as initial undervaluation, convergence, Balassa-Samuelson effects, and the implications for joining the Eurozone. It highlights the significant relative appreciation in most New Member States (NMS), except Cyprus, Malta, and Slovenia. The study delves into the impact of income, price levels, productivity, and growth rates on exchange rate dynamics. The author emphasizes the importance of understanding the equilibrium phenomenon of catching-up and the necessity of transitioning to the Euro with minimal welfare loss.

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Catching-up of new member countries and the real exchange rate appreciation

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  1. Catching-up of new member countries and thereal 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 • Significant relative real appreciation of most NMS - Cyprus, Malta, Slovenia excepted- price- labour cost • No difference according to the growth rate

  5. Interpretation • Initial undervaluation vs convergence • Explanatory factorsa) BSb) PPP

  6. BS • DefinitionsA) positive link bw income and price levelB) low nontradable productivityC) higher growth of tradable productivity • Classificationunchanged traded and nontraded sectors or activities • Endogenous tradabilitytrade/transportation costs • Measurement

  7. PPP • Sectors – composition effect • Products – aggregation level • Bar code data bw US and Canadalarge differences vanish fastsmall differences persistzero border-distance equivalent • QualityPrice increase: inflation + quality?

  8. Policy issues • Exchange rate regimeinflation vs nominal appreciation • Maastricht criteriasustainabilityvolatility • Real vs nominal convergence • Early vs late entry

  9. Conclusions • Real appreciation is an equilibrium phenomenon of catching-up • Different explanations: BS, quality, pricing more micro evidence is needed • Real and nominal convergence includes price level convergence • Euro is a must • Maastricht inflation criterion is inappropriate • 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)

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