The Eastward enlargement of the European monetary union

Abstract

The enlargement of the European monetary union to include new EU Member States (NMs) will not lead to higher expected inflation in the enlarged euro area, but only to some redistribution of inflation at the country level, if the policy framework of the monetary authority remains invariant. Shocks to the real exchange rate may affect instead aggregate inflation, if member countries' economic structure differs. The numerical results indicate that the impact on steady state inflation of the current euro area is limited if participating countries are weighted on the basis of nominal GDP and if the upward pressure on the real exchange rate is postulated to be in line with most estimates of the Balassa-Samuelson effect. In the event of real exchange rate or country-specific supply shocks in NMs, the consequences are found to be limited for the current and the enlarged euro area, but sizeable for the NMs themselves.