How did the Euro Affect Inflation Rates in the EMU?

Abstract: This bachelor thesis examines the convergence properties of inflation rates of the Euro-pean Monetary Union (EMU) countries over the period 1992 to 2007. The period can be naturally split into two periods, according to the Maastricht Treaty and the introduction of the Euro. Since countries were striving to meet the Maastricht inflation criterion for 1997 we will analyse inflation behaviour of the pre-Euro period (1992 to 1997) and post-Euro period (1998 to 2007), in order to see whether each country’s inflation rates have con-verged to the calculated mean of the sample. To analyse the issue we used CPI inflation rate data from IMF Statistical Database over the period 1992 to 2007. We study convergence by means of ADF unit-root tests, Engle-Granger cointegration tests and Johansen cointegration tests. These are complemented with descriptive statistics that measure dispersion of inflation rates within the EMU. The conclusion to the research problem can be summaries as follows: Our analysis pre-sents clear evidence of reduction in inflation rate dispersion for the period 1992 to 1997, indicating that the Maastricht Treaty had a major impact on the convergence of inflation rates within the EMU for that period. However, we found that only two countries, Austria and Portugal, had a cointegration relationship with the average rate of inflation of the other countries in the sample. For the period 1998 to 2007, the descriptive statistics indicated that the introduction of the Euro resulted in a divergence of inflation rates within the EMU. Those results were further strengthened by the fact that no cointegration relation-ship was found for that period.