EMU enlargement and convergence of price levels : lessons for German reunification, Mimeo, De Nederlandsche Bank

We analyse the possible impact of EMU enlargement on inflation rates in the ac-cession countries. We establish two main points: first, using a theoretical model we show that if large initial differences in price levels occur, even under very favourable circumstances the optimal path for price adjustments should be asym-metric, i.e. occuring mostly in the candidate countries. Second, based on data from the German reunification we quantify the inflationary effect of price level conver-gence in the accession countries. Our findings indicate that (trend) inflation rates in the EMU candidate countries are likely to increase sharply, whereas the impact on the current euro area is likely to be small, albeit not negligible. Our results sup-port the need to allow for some flexibility in the exchange rate arrangements with the candidate countries to facilitate gradual price level convergence prior to EMU enlargement