Abstract:
This paper studies the impact of real convergence in the EU countries on inflation synchronization between these countries and the Eurozone. Inflation co-movement between the Eurozone and the EU countries serves as an important measure of the adequacy of the single monetary policy for both current and future members of the common currency area. We report three major results. First, countries with higher relative GDP per capita in the EU countries report stronger inflation co-movement. Second, the relationship between real convergence and the inflation synchronization is non-linear. Third, lower income inequality is associated with greater inflation co-movement. Our findings suggest that real convergence in the EU is associated with stronger inflation synchronization between the EU countries and Eurozone and more effective common monetary policy in the long run. These results provide support for the “coronation theory” which underscores that monetary integration should follow, rather than precede, the process of real convergence. We show that for the catching-up countries with relatively high GDP per capita the value of waiting for the income gap to narrow is limited as additional convergence implies only moderate increase in inflation co-movement.
