Is there room for convergence in the E.C.?

Abstract

In the Maastricht Treaty (1991) the E.C. countries specified conditions for the transition to a monetary union. Two of these conditions that are necessary for admitting a country to the monetary union are represented by convergence in consumer price inflation and convergence in long term interest rates. In our paper [1] we develop a theoretical framework which makes it possible to analyze these aspects of convergence between E.C. countries. The analysis is done in a dynamic game context, where countries, apart from minimizing individual cost functions, minimize cooperatively a convergence function. This convergence function represents the above mentioned convergence conditions. The aspect of convergence is modeled as a dynamic constraint on the individual cost functions. In this way, the costs are modeled of E.C. countries which are involved in the proces of moving towards an Economic and Monetary union, which should be established (at least) in 1999. One important result of the paper is that the maximum degree of convergence is completely determined by the non-cooperative outcome of the game. In this extended abstract we illustrate this analysis in a theoretical example. The example shows that: (1) the goals with respect to convergence can seriously influence the outcome of the game. If these goals are set too ambitious the outcome can be that countries are not willing to cooperate anymore. (2) the costs involved to obtain convergence can differ substantially between countries.