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Real Convergence And Its Illusions

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Executive Summary

This paper uses the EAGLE, a multi-country dynamic general equilibrium model, to illustrate dynamic adjustments in a small open economy undergoing real convergence. The authors consider the effects of productivity catch-up and misperceptions about future productivity developments. The results indicate that even if real convergence takes the form of a gradual process, the dynamic responses of key macrovariables can be far from smooth. They also find that overly optimistic expectations about productivity shifts can generate sizable boom-bust cycles and so be relevant in accounting for cyclical deviations from a sustainable real convergence path.

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