Can We Have Both? - Real and Nominal Convergence

Candidate countries for accession to the EU often view EU convergence criteria as difficult given that the period of faster growth that real convergence necessitates is usually associated with higher inflation. This paper argues that it is important to focus on the mechanism of real convergence in this regard. If economic growth is accelerated by virtue of the closing of a technology gap, the processes of nominal and real convergence can indeed be compatible. In order to analyze this hypothesis, model simulations were run for five accession countries assuming a scenario in which FDI increases exogenously. The model used for simulation is a modified version of the model used in a related research project of Barrell, Holland, Kovacs, Jakab, Smidkova, Sepp, and Cufer (2001). According to simulation results, CPI falls and GDP per capita increases compared to the baseline following the introduction of an FDI shock. Although the results are not identical for all five countries, the hypothesis of compatibility of convergence criteria is generally supported.