EU-Enlargement, the economic convergence between EU-15 and CEECs, and the transitional dynamics of the real Euro-Dollar exchange rate

On May 1st 2004 eight CEECs entered the EU together with Malta and Cyprus. The Fifth Enlargement initiates the biggest convergence process which has ever taken place within the EU strongly affecting the economic relations between the EU-25 and other large world economies. This paper presents a new endogenous growth model of the world economy consisting of the Euro and Dollar areas mainly connected by the real exchange rate. The CGE analysis focuses on the impacts of the post-enlargement convergence process on the transitional dynamics of the real Euro-Dollar exchange rate. The immediate effect of the enlargement is a heavy increase of the Euro-Dollar exchange rate and a strong decline of EU-15-capital intensity. Afterwards the real exchange rate starts decreasing while both the EU-15 and the CEEC capital intensity increase towards the steady state of full convergence. Lastly, the effects of different EU-25 tax and public expenditure policies on the transitional dynamics are explored.