Series: Working Papers. 2010.
Author: Alfredo García-Hiernaux, María T. González-Pérez and David E. Guerrero.
Topics: Economic growth and convergence | Monetary policy | Prices and margins | Inflation | Economic and Monetary Union | International Economy.
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Abstract
This article provides a methodology to test absolute and relative price convergence
(in mean and variance) based on a model of relative prices that includes a transition
path, and offers a way to measure the speed of price convergence across countries.
By applying this test to the European Monetary Union (EMU) price indices from 2001 to
2011, we find empirical evidence of different price level patterns and the lack of price
level convergence in the long run for most countries. In terms of the price gap between
countries, only when we compare the German with French and Italian prices, we do get
zero-gap (absolute) price level convergence. A few other countries report relative price
level convergence. These results underscore the existence of a “convergence cost” that
EMU countries with lower price levels paid and that does not tend toward zero in the
long-term in the absence of convergence. This finding might be of particular interest to
European monetary policymakers as it implies that implemented monetary policy does
not affect (benefit/harm) all EMU members equally. Monitoring the relative and absolute
price level convergence is advised to understand the monetary policy efficiency in
the long run.