Price-Level Convergence in the Eurozone: A Brief History of Convergence and Divergence

Abstract

This paper shows that price level trends in many of the EMU countries evolve with different patterns and that these patterns will not converge in the long-run. We propose that the hypothesis of price convergence should be evaluated and tested employing the relative prices. To this aim, we: (i) define the asymptotic price level convergence in mean and variance, (ii) provide a model for relative price levels that includes a transition path, and (iii) show how to properly test the definitions stated. Our results show that only French and German price levels converge in mean to a zero gap in the EMU while some others, not many, converge to a non-zero significant gap. This should be a matter of concern for the European monetary policy makers as it implies that the monetary policy does not affect all the EMU members equally.

Keywords: Inflation Convergence, Price Level Convergence

JEL Classification: C22, C32, N70, E3, E4, E5