economic convergence 1. nominal and real convergence : what has been achieved? the first aspect of convergence relates to developments in terms of nominal and real convergence between the countries of central and eastern europe and the euro area. looking at the region as a whole, after some very difficult years, inflation has come down dramatically from very high levels at the beginning of transition to single - digit levels today. long - term interest rates have also fallen substantially, reflecting the gradual anchoring of inflation expectations. the countries of the region have also made remarkable progress in terms of institutional and structural convergence. in particular, we have witnessed the building of appropriate institutions, increased trade integration with the euro area and improvements in the business environment. naturally, this progress has been reflected in per capita income convergence. over the last 20 years, per capita income has risen to an average of 63 % of the eu average if adjusted in terms of purchasing power parity ( ppp ). but combining low inflation with real convergence has posed a serious challenge in many countries. let me elaborate on this. the very process of real convergence entails upward pressures on prices, which can be hard to avoid in terms of both relative prices and the overall price level. among other things, these pressures stem from high productivity growth as well as the processes of price liberalization and tax harmonization. price increases related to productivity growth are usually referred to as the balassasamuelson effect. but most studies have found this effect to be relatively limited. 1 convergence in price levels, which stood on average at two thirds of the eu average in 2010, seems to have surpassed convergence in income levels in all countries of the region. this means that growth in prices has generally been higher than growth in productivity. potential rigidities in labour and product markets and, in some cases, an excessively loose macroeconomic stance may have complicated the delivery of low inflation rates. indeed, while all countries have reduced inflation to moderate levels, the entrenchment of a low inflation environment still constitutes a challenge in many economies. 2. importance of ensuring polices that support fast and sustainable output growth the second aspect of convergence that i would like to highlight relates to the growth model followed by some new eu member states. given its lower starting point in terms of real income, it could be expected that, in a world with full financial integration, large capital inflows would flow into the region. moreover, as people expect to be richer tomorrow than today, they may choose to smooth consumption

headline inflation are likely to hover around current levels in the coming months. measures of underlying inflation remain subdued and have yet to show convincing signs of a sustained upward trend. muted wage dynamics are one important element keeping a lid on underlying price pressures. these are shaped by many factors. in addition to weak productivity developments, the significant degree of remaining labour market slack is limiting wage growth. when assessing slack, it is important to look also at broader measures than the unemployment rate. the so - called “ u6 measure ” captures unemployment, underemployment ( meaning workers who would like to work more hours ) and marginal attachment, which refers to those members of the workforce who are not seeking employment very actively either because, for example, they are not available to start a new job at short notice or have been discouraged by a fruitless search for work. the u6 measure currently covers around 17 % of the labour force and is thus considerably higher than the unemployment rate. 5 looking forward, although there still appears to be a disconnect between growth and inflation, the ongoing economic expansion is expected to further contribute to a narrowing of the output and unemployment gaps. as slack in the economy continues to be absorbed, price pressures will gradually build up and the traditional phillips curve relationship between inflation and the business cycle should eventually reassert itself. that being said, current estimates still appear to point to a flatter slope of the phillips curve than in the past, which could be interpreted as an indication that the relationship between economic slack and inflation has weakened. this weakening might be partly the result of a mismeasurement of slack ( because of structural changes in the labour market ) or an unstable relationship between slack and inflation over time. at the same time, this effect could also result from discrete parallel shifts in the phillips curve. such parallel shifts can arise due to temporary changes in wage and inflation mark - ups or an incipient dis - anchoring of inflation expectations, which is of greater concern to a central bank. empirically disentangling these factors is extremely difficult, so we need to be mindful of such considerations when discussing the relationship between economic slack and inflation developments. our primary task as a central bank is to ensure that the traditional relationship between the real and the nominal sides of the economy reasserts itself at a steady - state rate of inflation that is below, but close to, 2 %. we have not yet accomplished our mission : with inflation convergence proceeding only 2 /