Is the Euro Area Converging or Diverging? Implications for Policy Co-ordination
Author(s)
Lenain, Patrick; De Serres, Alain
Abstract
The questions that this paper asks are twofold. First, why is the real exchange rate adjustment channel working imperfectly? The response to this question rests essentially in the presence of asymmetries in the inflation-output nexus. In the small overheating economies, the real exchange rate appreciation has been limited and the impact on foreign demand has been small. In large economies, due to price and wage rigidities, slow growth has not induced sufficient disinflation to depreciate the real exchange rate. Hence, the second question raised in this paper is what fiscal policy can do to play a more effective role in reducing divergences. While in principle fiscal policies can play a role in reducing cyclical divergences, in particular by allowing the free play of automatic stabilisers, they have not done so in the first years of EMU (European Monetary Union).
