Income convergence and inflation in Central and Eastern Europe : does the sun always rise in the East

This paper investigates the process of price convergence in the 10 new EU countries from Central and Eastern Europe. The analyses are based on panel data from 1995 to 2008 of the common currency price relative to the EU15 average. The lagged income level exhibit little explanatory power towards relative inflation, while the lagged price level has some explanatory power. In the long term the relative income and price levels are closely correlated implying concurrent nominal and real convergence. Deviations from the long-term relation between price and income levels are gradually closed by changes in relative inflation and GDP growth, but the process of convergence appears to be rather slow. In the short term the capital inflows associated with current account deficits put substantial upward pressure on the relative price inflation, while the Balassa-Samuelson effect appears to be subdued