Patterns of Convergence and Divergence in the Euro Area

By A. Estrada, J. Gali and D. Lopez-Salido; 2013

Agenda

1. Introduction

2. Unemployment Rate

3. Inflation

4. Relative Price Levels

5. CA Imbalances and Price Competitiveness

6. Conclusion

1. Relevance

Question: Did European monetary integration foster stronger convergence/divergence in the EA in comparison to other non-euro advanced economies?

Motivation: since the onset of the sovereign debt crisis macroeconomic performance across EA countries has been increasingly heterogeneous

1. Main resultsVariables of interest: Unemployment rate, inflation, price competitiveness, price competitiveness and current account (CA) imbalances

Results: 1. Strong convergence in unemployment rates in EA and non-euro economies until the

outbreak of the crisis, then stronger divergence in the EA

2. Strong convergence of inflation rates in EA and other advances economies over the past 250 years, but persistent differentials in the EA since the introduction of EMU

3. Substantial convergence in prices of traded goods in the EA, in contrasts to other developed economies

4. Large differences in CA developments across EA countries, mainly drive by non-price competitiveness

Agenda

1. Introduction

2. Unemployment Rate

3. Inflation

4. Relative Price Levels

5. External Imbalances and Price Competitiveness

6. Conclusion

2. Unemployment Rate

2. Unemployment Rate

- Large divergence in unemployment rates across the EA

- So did monetary integration lead to more similar labor market performance or stronger divergence?

- Use the performance of a control group to verify: US, Japan, Canada, UK, Sweden, Denmark, Switzerland, Australia, New Zealand

- Annual data from 1985-2012

+

2. Unemployment rate

- Evidence of convergence of unemployment rate across EA countries prior to the crisis, is not stronger than in non-euro countries

- dispersion during The crisis is stronger in the EA

Might indicate that a common currency without other risk-sharing devices might drive divergence in unemployment rates

Agenda

1. Introduction

2. Unemployment Rate

3. Inflation

4. Relative Price Levels

5. External Imbalances and Price Competitiveness

6. Conclusion

3. Inflation

3. Inflation

3. Inflation- Most of inflation convergence in the EA took place before

EMU (white area), as well as for non-euro economies

- Starting with EMU, EA countries continue to converge both in the expansion and recession phase (green and red areas)

- Whereas non-euro convergence took a hold since 1999, which mostly due to the outliers Japan and Switzerland

thus there is little evidence that the creation of EMU significantly helped with inflation convergence

Agenda

1. Introduction

2. Unemployment Rate

3. Inflation

4. Relative Price Levels

5. External Imbalances and Price Competitiveness

6. Conclusion

4. Relative Price Levels

4. Relative Price Levels

4. Relative Price Levels

- Convergence of relative price levels in EA countries tarts before the creation of EMU, but is persistent during EMU times

- Whereas convergence in non-euro countries has strong fluctuations due to exchange rate volatility (all prices expressed in US$)

4. Relative Price Levels

4. Relative Price Levels

Agenda

1. Introduction

2. Unemployment Rate

3. Inflation

4. Relative Price Levels

5. External Imbalances and Price Competitiveness

6. Conclusion

5. External Imbalances and Price Competitiveness

5. External Imbalances and Price Competitiveness

⁻ CA imbalances of EA countries was quite moderate prior to EMU

⁻ Most imbalances built up since 2007 and reversed in 2009 due to reduction of deficits

Now: Estimate relationship with OLS for

5. External Imbalances and Price Competitiveness

⁻ CA imbalances of EA countries was quite moderate prior to EMU

⁻ Most imbalances built up since 2007 and reversed in 2009 due to reduction of deficits

Now: Estimate relationship with OLS for

5. External Imbalances and Price Competitiveness

- Sig. neg. impact of GDP growth on CA changes in EA countries, strong cyclical relationship

- Measures of price competitiveness: relative price of tradable goods and unit labor costs

- Rel. increase in prices have a sig. negative impact on CA changes in EA countries, this does not hold for the control group

- Unit labor costs have a higher explanatory power than rel. prices of tradable goods

5. External Imbalances and Price Competitiveness

- Explore which factors linked to competitiveness could drive the CA imbalances

- Use the Global Competitiveness Index (GCI) constructed by the Forum

5. External Imbalances and Price Competitiveness

- Explore which factors linked to competitiveness could drive the CA imbalances

- Use the Global Competitiveness Index (GCI) constructed by the Forum

5. External Imbalances and Price Competitiveness

- Explore which factors linked to competitiveness could drive the CA imbalances

- Use the Global Competitiveness Index (GCI) constructed by the Forum

5. External Imbalances and Price Competitiveness

- The explanatory power of the competitiveness index has a much higher explanatory power for EA countries than for other developed countries

- Hence non-price disparities play a larger role among EA countries to explain CA imbalances

- Good market efficiency play an important explanatory role in the EA, but not in other developed countries

Agenda

1. Introduction

2. Unemployment Rate

3. Inflation

4. Relative Price Levels

5. External Imbalances and Price Competitiveness

6. Conclusion

6. Conclusion- Unemployment rates in the EA and other developed countries

have been converging over the last decades, the recent recession has lead to a large dispersion especially among EA countries

- Strong inflation convergence among both groups of countries, most convergence before the introduction of EMU

- In contrast to other developed countries, CA imbalances among EA countries seem to be driven largely by non-price competitiveness factors, thus internal devaluation policies has little success in reducing the external balance if not accompanied by structural reforms