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Heterogeneity, convergence and imbalances in the Euro area

Abstract : The inception of the euro allowed countries from the periphery to experience a large fall in the cost of borrowing. Lower nominal rates were only partially offset by lower inflation rates. We rationalize this real interest rate reversal using a two-region model of a monetary union where, consistently with real interest rate data, discount factors are initially heterogeneous, leading the periphery to be borrowing-constrained. We model the inception of the euro as a partial convergence process in inflation rates and a slow rise in the discount factor of the periphery, relaxing the borrowing constraint. This simple setup accounts for the bulk of post-euro fluctuations in both regions. In particular, it replicates very well the observed joint dynamics of current accounts and terms of trade.
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Submitted on : Friday, October 22, 2021 - 11:32:42 AM
Last modification on : Tuesday, December 7, 2021 - 8:56:46 AM
Long-term archiving on: : Sunday, January 23, 2022 - 7:21:56 PM


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Stéphane Auray, Aurélien Eyquem. Heterogeneity, convergence and imbalances in the Euro area. Revue de l'OFCE, Presses de Sciences Po, 2021, VARIA, 3 (173), pp.117-152. ⟨hal-03394885⟩



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