Real Exchange Rate Dynamics
in the New Member States of the EU –
Run-up to the Euro.
PhD thesis, National University of Ireland Maynooth.
This dissertation contributes to the literature addressing the euro adoption by the
New Member States (NMSs) of the European Union by proposing a definition of
real convergence based on real exchange rate (RER) dynamics. As fluctuations in
RER represent deviations from purchasing power parity (PPP), the thesis also adds
to the literature on PPP theory. Finally, by proposing basic and extended small open
economy dynamic stochastic general equilibrium international real business cycle
(SOE-DSGE-IRBC) models of RER determinants for the NMSs, it fills a gap that
has hitherto existed in the literature.
The analysis of RER dynamics is conducted on two levels: empirical and theoretical.
On the empirical level, the scale of RER dynamics in the NMSs is measured. Factors
contributing to these dynamics are identified. Particular attention is drawn towards
the factors which could account for the recorded appreciation of RER in these
countries since the early 1990s. On a theoretical level, variants of the
SOE-DSGE-IRBC model of RER determinants for a typical NMS are developed.
The findings of Chapter 1 show that the univariate variance analysis accurately
measures real convergence in the analysed countries. The results also indicate that at
present, only Estonia and Slovenia (ex post) are ready to adopt the euro. The basic
SOE model of Chapter 2, unlike its expanded version of Chapter 3, is only able to
roughly match the moments of the Polish data. Therefore, its findings provide
insights into the theoretical ‘puzzle’ of RER volatility and its persistence. The
expanded model results show that productivity shocks to the non-traded sector are
the main cause of price differentials between Poland and the euro area. This is in
contrast to the two competing hypotheses that either productivity or quality
improvements in the tradable sector are the main source of real exchange rate
appreciation in this country.
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