nr 010 - EMU Enlargement, Inflation and Adjustment of Tradable Goods Prices: What to Expect?

Inflation differentials resulting from EMU enlargement have so far mostly been discussed within the Balassa-Samuelson framework, i.e. resulting from inflation in nontradable goods. We analyse the inflationary consequences of convergence of tradable goods’ prices. Using disaggregated price level data, simulations show that inflation in the new EU member states might on average be 1.5-3.5 percentage points higher than in the current euro area (with considerable variation between the new EU members). These inflationary effects even exceed most simulations of the Balassa-Samuelson effect. The ‘burden of adjustment’ rests mainly on the shoulders of the new EU members if the European Central Bank sets monetary policy in response to inflation developments in the entire currency area. In contrast the impact of EMU enlargement on the current euro area is limited, due to the small economic weight of the new EU member states. Keywords: Price level differences, convergence, EMU enlargement, JEL codes: E30, E31, E50, F40