The Role of the Exchange Rate Regime in the Process of Real and Nominal Convergence

Gaetano D'Adamo () and Riccardo Rovelli

No 7627, IZA Discussion Papers from Institute of Labor Economics (IZA)

Abstract: During the last decade, economists have intensively searched for evidence on the importance of the Balassa-Samuelson (B-S) hypothesis in explaining nominal convergence. One general result is that B-S can at best explain only part of the excess inflation observed in the European catching-up countries, which suggests that other factors may be at play. In these and related studies, however, the potential role of the exchange rate regime in affecting price convergence in Europe has been overlooked. In this respect, we claim that the choice of the exchange rate regime has decisively affected the path of nominal convergence. To show this, we first model the (endogenous) choice of the exchange rate regime and, in a second stage, estimate a B-S type of regression for each regime. Our results show that, for countries which pegged to or adopted the euro, the effect of the same increase in the dual productivity growth (that is, the difference in productivity growth between the traded and non-traded sectors) on the dual inflation differential is more than twice as large as that in the "flexible" countries. We conclude that, in a catching-up country, premature euro adoption may foster excess inflation, beyond that which is to be expected as a consequence of productivity convergence on the basis of the B-S effect.

Keywords: inflation; Balassa-Samuelson effect; exchange rate regimes; euro adoption (search for similar items in EconPapers)
JEL-codes: C34 E52 F31 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2013-09
New Economics Papers: this item is included in nep-cba, nep-eec, nep-mac, nep-mon and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations:

Published - revised version published in: Journal of Macroeconomics, 2015, 43, 21-37

Downloads: (external link)
https://docs.iza.org/dp7627.pdf (application/pdf)

Related works:
Journal Article: The role of the exchange rate regime in the process of real and nominal convergence (2015)
Working Paper: The role of the Exchange Rate Regime in the process of Real and Nominal Convergence (2013)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:iza:izadps:dp7627

Ordering information: This working paper can be ordered from
IZA, Margard Ody, P.O. Box 7240, D-53072 Bonn, Germany

Access Statistics for this paper

More papers in IZA Discussion Papers from Institute of Labor Economics (IZA) IZA, P.O. Box 7240, D-53072 Bonn, Germany. Contact information at EDIRC.
Bibliographic data for series maintained by Holger Hinte ().