Measuring convergence of the new member countries' exchange rates to the Euro

We propose a common factor approach to analyse convergence, which we implement using principal components analysis. This technique has not been used to analyse convergence of time series but is shown to provide a useful new tool. We show how it is in many ways a more natural way of approaching the convergence debate. We apply these ideas to a dataset of bilateral Euro and US-Dollar exchange rates of the new member countries of the European Union. Our empirical application gives sensible results about the convergence process of the new member countries’ exchange rates to the Euro.