Real Exchange Rate Convergence in the Euro Area : Evidence from a Dynamic Factor Model

We apply a dynamic factor model using Bayesian methods to estimate andcompare the dynamics of real exchange rate (RER) convergence of the originalEuropean monetary union (EMU) member countries both before and after theintroduction of the euro with those of a larger sample of European countries. Wefind the convergence speed in the EMU members to have accelerated substantiallyfrom the mid-2000s, stalling only briefly in the wake of the Great Recessionof 2007-09 and the subsequent European debt crisis of 2010-12. In contrast, thespeed of RER adjustment for the larger sample of European countries displaysa secular slowdown lasting to the end of the sample in the late 2010s. Theevidence suggests that the EMU members in fact experienced genuine exchangerate stabilization, particularly during the latter years of the sample