External and Macroeconomic Adjustment in the Larger Euro‐Area Countries

• Date: 01 December 2016
• Author: Elena Angelini,Katrin Forster van Aerssen,Michele Ca’ Zorzi
• DOI: http://doi.org/10.1111/infi.12098
• Published date: 01 December 2016

External and Macroeconomic

Adjustment in the Larger

Euro-Area Countries

Elena Angelini

y

, Michele Ca’Zorzi

z

and Katrin Forster van Aerssen

§

y

DG-Research, ECB,

z

DG-International and European Relations, ECB,

and

§

DG-Economics, ECB.

Abstract

A balanced current account in the euro area has disguised sizable imbal-

ances at the country level, exposing the common currency area to severe

pressures during the financial crisis. The key contribution of this paper is to

evaluate the adjustment process using the New Multi Country Model

(NMCM) at the country and sectoral levels. The model suggests that a

recovery in wage competitiveness reduces external deficits but has only

mildly expansionary effects at the cost of higher net borrowing by house-

holds. It also suggests that the impact of an aggregate demand shock in

Germany is not enough to lead to a rebound in economic activity and

address external imbalances in the rest of the euro area. Finally, the

presence of supportive external conditions, while facilitating the implemen-

tation of vital reforms, would not necessarily unravel intra-euro-area

imbalances.

We are grateful for the insightful comments of A. Willman , L. Dedola, A. Dieppe, G . Kenny, G.

Lombardo, M. Rubaszek, F. Smets, two anonymous referee s as well as particip ants of ECB and ESCB

seminars. The views e xpressed are those of the authors and d o not necessarily reflect th ose of the

ECB.

International Finance 19:3, 2016: pp. 269–291

DOI: 10.1111/infi.12098

© 2016 John Wiley & Sons Ltd

I. Introduction

The current account in the euro area has histori cally been close to bala nce. The

pattern of deficits and surpluses across the d ifferent participat ing Member States

was generally not pe rceived as a major policy issu e. Although normative approach es

signalled that cur rent account positions at the gl obal level, as well as in the euro

area, were out of balance,

1

the currency union d imension provided a ration ale for

why net lending was flowing downh ill, that i s from the high p er-capita gross

domestic product (GDP) countries to the emerging periphery (Blanchard and

Giavazzi 2002, Blanchard 2007) –under a scenar io of economic convergence.

2

With the benefit of hindsight, n et lending de velopments in the euro area should

have been seen as worrisome, not only b ecause they were driven by low savings

rather than investment in productive capital (Lane and Pels 2012), but also because

large external li abilities represented an imp ortant source of risk in cases of l iquidity

shortage. Revisit ing recent events in the euro area, Obstfeld ( 2012) also stressed th at

the country dimensi on still matters. As the cr isis deepened, th e common currency

dimension proved to be important due to the larg e supportive role of the European

Central Bank (ECB), but i ncreased financial ma rket segmentation, r ising borrowing

costs and strong recession ary forces underlin ed the risk to euro-area Member St ates

of accumulating too much public and private debt.

The pressures that emer ged in several periph eral euro-area countrie s, starting in

some of the smaller countrie s and later reaching Spai n and Italy, have indeed

triggered a re-balancing process that is visible along a number of dimensions. In

particula r, the large current-accou nt divergence among euro-a rea countries has

narrowed, driven by changes in the savin gs and investment of the public and pr ivate

sectors (Atoyan et al. 2013). The external re-balancing adjustm ent has also been

considerably larg er in the countries hit hardest by the cri sis. But even where externa l

deficits are now lower or turned slig htly positive, this d evelopment is not entirely

good news, as it could p artly reflect weak economic growth and the sudden

withdrawal of foreign capi tal. Fiscal consolid ation and a collapse in consum er and

investor confidence have had signific ant recessionary impac ts. Coupled wit h strong

private capital outflows, in some cases this has led to substantial increases in

unemployment.

The main contributi on of this paper is to go be yond a normative assess ment of

whether the cur rent account position of a given countr y is in line with economi c

fundamentals, as s een in much of the reduced-form panel-data literature (Chinn and

1

See the methodologi cal frameworks proposed by Chinn and Pras ad (2003) and Lane and Mi lesi-

Ferretti (2005), als o applied in Rahman (200 8) and Ca’Zorzi et al. (2012a,b).

2

Lucas (1990) noted the parad ox that at the global level finan cial capital was flowing uphil l, that is

from the poor to the rich countries . Until recently the euro area represented an excepti on, as private

capital was flowing to the emerging periphery.

270 Elena Angelini et al.

© 2016 John Wiley & Sons Ltd