A NEW LOOK AT ECONOMIC CONVERGENCE IN EUROPE: A COMMON FACTOR APPROACH

We propose a common factor approach to analyse convergence. which we implement using principal components analysis. We show that this method provides a useful new way of approaching the convergence debate. We apply this technique to a data set of monthly exchange rates of the 12 member countries of the European Monetary Union (EMU) over 1970-2001. Our empirical results neatly capture the convergence patterns related to the various regimes from Bretton Woods towards EMU. The UK's Pound Sterling has been on a gradual convergence path to the Euro, although convergence is less progressed than it was for the EMU Countries by 1999. Copyright (C) 2008 John Wiley & Sons. Ltd.