How is real convergence driving nominal convergence in the new EU Member States?

We evaluate the empirical relevance of real convergence on the process of nominal convergence for the new EU Member States. We focus our discussion on two main channels: productivity growth and increased trade openness. Productivity growth can have a positive effect on price levels via the Balassa-Samuelson effect, whereas increased openness leads to reductions in mark-ups and costs and therefore can have a negative impact on prices. We empirically assess their relevance using a Structural VAR model to which we applied a model reduction algorithm. Our findings show that, in general, openness has had a negative impact and productivity growth a positive one on price level convergence with respect to the euro area. (C) 2007 Elsevier Ltd. All rights reserved.