Real Convergence and Inflation : Quantification and Implications for Integration with the Euro Area

The cross-country regression relating the relative price level to the relative GDP level is significant and stable. But there is no shorter-term trade-off between fast real convergence and low inflation. Such a tradeoff characterises the dynamic process moving the economy along the regression line. But the actual dynamics may run off that line. High inflation is not necessary for fast convergence. Giving up the national currency is risky. It may stop convergence or precipitate divergence. Problems may also emerge when the initial parity is weak. Inability to nominally devalue may prove very costly. While retaining the national currency is not risk-free, it does not rule out a corrective devaluation