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 © 2008 John Wiley & Sons, Ltd.
- exchange rates
- European Monetary Union
- nominal convergence
- real convergence
- principal components analysis