Jon Håkon Findreng

MSc in Financial Economics

Norwegian School of Economics

Norway

E-mail:j.findreng@gmail.com

Relative Purchasing Power Parity and the European Monetary Union: Evidence from Eastern Europe

ABSTRACT. This paper examine whether relative purchasing power parity holds for Albania, Bulgaria, Croatia, FYR Macedonia, Romania and Turkey versus Germany over the period January 1999 to May 2013. We investigate the real exchange rate by using a Dickey-Fuller test. Thereafter, we investigate the real exchange rate by allowing for a trend with the origin in the Balassa-Samuelson effect. We also investigate the same pairs using the Engle-Granger cointegration test. However, for the Engle-Granger cointegration test, four of the pairs are excluded as the nominal exchange rate and the price differential are not integrated by the same order. We have investigated the half-life of each pair in each of the three approaches. We find ambiguous results both regarding relative PPP and the speed of adjustment towards the PPP equilibrium. We use the results to investigate whether the Albanian, Bulgarian, Croatian, FYR Macedonian, Romanian and Turkish economies are synchronized with the German economy and if they are ready to enter the European Monetary Union.

Received: December, 2013

1st Revision: March, 2014

Accepted: April, 2014

DOI:10.14254/2071-789X.2014/7-1/3

JEL Classification: E5, E31 F33

Keywords: Consumer Price Index, Monetary Policy, Monetary System, Currency Union, EMU, Exchange Rates, Economic Indicators