The dispersion in current account balances among countries in the euro area has widened markedly over the past decade-and-a-half, and especially since 1999. The authors decompose current account positions for euro area countries into intra-euro-area balances and extra-euroarea balances and examine the determinants of these balances. Regarding intra-euro-area balances, they present evidence that capital tends to flow from high-income euro area economies to low-income euro area economies. These flows have increased since the creation of the single currency in Europe.
Authored by: Alan Ahearne, Brigit Schmitz, Jürgen von Hagen
Published in 2007
This study reviews monetary policy options that are seemingly viable for adopting the euro by the new Member States of the European Union. A fully autonomous direct inflation targeting is believed to be suboptimal for convergence to the euro as it does not incorporate convergence parameters into the central bank reaction function and instrument rules. In an attempt to correct for such deficiency, this study advocates adopting a framework of relative inflation forecast targeting where a differential between the domestic and the eurozone inflation forecasts becomes the main objective of the central bank's decisions.
At the same time, some attention to the exchange rate stability objective becomes necessary for facilitating the monetary convergence process. Foreign exchange market interventions, rather than interest rate adjustments, are viewed as a preferred way of achieving this objective.
Authored by: Lucjan T. Orlowski
Published in 2005
The aim of the paper is to analyze theoretically and empirically the likely impact of the reduction in exchange rate uncertainty, due to the EMU accession, on the intensity of FDI inflow into candidate countries. Theoretical models give an ambiguous picture of how exchange rate uncertainty and volatility affect direction and magnitude of FDI inflows. The main contribution of this paper is in finding that exchange rate uncertainty and volatility may negatively influence the decision to locate investment in transition and accession countries. Nominal exchange rate uncertainty seems to particularly hamper FDI inflows in accession countries. The key finding of this paper is that euro adoption is likely to exert a positive influence on FDI inflows in accession countries.
Authored by: Michal Brzozowski
Published in 2003
The Eurozone crisis mobilises an appreciable amount of the attention of politicians and the public, with calls for a decisive defence of the euro, because the single currency’s demise is said to be the beginning of the end of the EU and Single European Market. In our view, preserving the euro may result in something completely different than expected: the disintegration of the EU and the Single European Market rather than their further strengthening. The fundamental problem with the common currency is individual countries’ inability to correct their external exchange rates, which normally constitutes a fast and efficient adjustment instrument, especially in crisis times.
Europe consists of nation states that constitute the major axes of national identity and major sources of government’s legitimisation. Staying within the euro zone may sentence some countries – which, for whatever reason, have lost or may lose competitiveness – to economic, social and civilizational degradation, and with no way out of this situation. This may disturb social and political cohesion in member countries, give birth to populist tendencies that endanger the democratic order, and hamper peaceful cooperation in Europe. The situation may get out of control and trigger a chaotic break-up of the euro zone,
threatening the future of the whole EU and Single European Market.
In order to return to the origins of European integration and avoid the chaotic break-up of the euro zone, the euro zone should be dismantled in a controlled manner. If a weak country were to leave the euro zone, it would entail panic and a banking system collapse. Therefore we opt for a different scenario, in which the euro area is slowly dismantled in such a way that the most competitive countries or group of such countries leave the euro zone. Such a step would create a new European currency regime based on national currencies or currencies serving groups of homogenous countries, and save EU institutions along with the Single European Market.
This paper has been also published in "German Economic Review" (Volume 14, Issue 1, pages 31–49, February 2013)
Authored by: Stefan Kawalec and Ernest Pytlarczyk
This paper presents an analysis of Portugal's economy from 1999 to 2015, providing an
alternative to explanations that present the situation faced by Southern European
countries after the Great Recession as a matter of excessive expenditure or loss in
competitiveness. Based upon the Sraffian Supermultiplier model, we look at how
demand components evolved along the analyzed period, in a growth accounting setting.
This assessment evidences that insufficient effective (public) demand -- not balance-ofpayments
constraints nor an alleged excess of public expenditure -- is what explains
Portugal's low-to-negative growth rates from 2001 forward. Given the limited
productive structure, a labor market that is not strong enough to guarantee a solid
internal credit expansion and the present institutional setting (which makes fiscal
expenditure an also limited source of effective demand), we conclude that the only way
for Portugal to abandon the low growth path would be a more cooperative fiscal stance
from the European Union.
Europ eco outlook 2 may 2013 hs_financelabFinanceLab
The document provides an economic and market update for Europe, with the following key points:
1) The euro crisis recovery is slow and fragile with differing speeds across countries. Germany is coping relatively well while others like Italy remain in difficult situations.
2) Financial markets have recovered somewhat on expectations of continued loose monetary policy, but the outlook remains uncertain.
3) The euro has weakened against the dollar and U.S. manufacturing, which could help the euro area recovery by boosting exports. However, long term the dollar is expected to strengthen versus the euro.
4) The European Central Bank has limited tools remaining to support growth as fiscal austerity continues to hamper a stronger recovery in many countries. The
An attempt is made to explore the basic implications of differences in productivity growth rates in countries within a monetary union and tailor them to the case of the EU new member countries running up to the EMU. By using the mathematical model of Harrod-Balassa-Samuelson effect and linking productivity and relative price dynamics with monetary policy, it is shown that: 1) productivity growth in faster-growing countries (FGC) leads to either inflation there, or union-wide exchange rate appreciation, or both in certain proportions, depending on the monetary policy stance taken by the union, but does not cause increase in inflation in slower-growing countries (SGC) by itself, unless the union’s monetary authorities take pro-inflationary policy; 2) because of presence of FGC, the SGC do not become less competitive in the world, and can benefit from increased export of their goods to FGC, provided their labour markets are flexible enough; 3) the real challenge for SGC posed by FGC is not inflation, but rather loss of jobs and export revenues, if their labour markets are not flexible enough to adjust under tight union-wide monetary policy aimed at keeping the union-wide overall price level unchanged, or the labour productivity increase in FGC is not met by adequate improvement in labour productivity in SGC. It should be noted, however, that this ‘adequate improvement’ is enough to constitute only a fraction of the productivity growth in FGC.
Authored by: Nikolai Zoubanov
Published in 2003
This document is a paper by Lubomira Anastassova titled "Institutional Arrangements of Currency Boards - Comparative Macroeconomic Analysis". The paper examines the differences in institutional frameworks for currency board arrangements across countries and assesses the impact of currency boards on macroeconomic indicators like inflation, interest rates, and economic growth. It finds that currency board countries exhibit approximately 3% lower annual inflation and 1% higher economic growth on average compared to other countries with pegged exchange rates. The paper analyzes the characteristics of currency boards, how their institutional arrangements can support successful economic development, and presents the results of a regression analysis testing the impact of currency boards on macroeconomic performance.
This document summarizes a working paper that examines the statistical properties of current account balances and their determinants across 70 countries. It finds that once regime shifts are allowed for using Markov-switching models, the null hypothesis of a unit root can be rejected for more countries than with standard linear unit root tests. The paper also investigates what country characteristics, such as exchange rate regimes, financial openness, and macroeconomic fundamentals, help explain differences in the likelihood of entering non-stationary current account regimes and in the degree of current account persistence across regimes.
This study reviews monetary policy options that are seemingly viable for adopting the euro by the new Member States of the European Union. A fully autonomous direct inflation targeting is believed to be suboptimal for convergence to the euro as it does not incorporate convergence parameters into the central bank reaction function and instrument rules. In an attempt to correct for such deficiency, this study advocates adopting a framework of relative inflation forecast targeting where a differential between the domestic and the eurozone inflation forecasts becomes the main objective of the central bank's decisions.
At the same time, some attention to the exchange rate stability objective becomes necessary for facilitating the monetary convergence process. Foreign exchange market interventions, rather than interest rate adjustments, are viewed as a preferred way of achieving this objective.
Authored by: Lucjan T. Orlowski
Published in 2005
The aim of the paper is to analyze theoretically and empirically the likely impact of the reduction in exchange rate uncertainty, due to the EMU accession, on the intensity of FDI inflow into candidate countries. Theoretical models give an ambiguous picture of how exchange rate uncertainty and volatility affect direction and magnitude of FDI inflows. The main contribution of this paper is in finding that exchange rate uncertainty and volatility may negatively influence the decision to locate investment in transition and accession countries. Nominal exchange rate uncertainty seems to particularly hamper FDI inflows in accession countries. The key finding of this paper is that euro adoption is likely to exert a positive influence on FDI inflows in accession countries.
Authored by: Michal Brzozowski
Published in 2003
The Eurozone crisis mobilises an appreciable amount of the attention of politicians and the public, with calls for a decisive defence of the euro, because the single currency’s demise is said to be the beginning of the end of the EU and Single European Market. In our view, preserving the euro may result in something completely different than expected: the disintegration of the EU and the Single European Market rather than their further strengthening. The fundamental problem with the common currency is individual countries’ inability to correct their external exchange rates, which normally constitutes a fast and efficient adjustment instrument, especially in crisis times.
Europe consists of nation states that constitute the major axes of national identity and major sources of government’s legitimisation. Staying within the euro zone may sentence some countries – which, for whatever reason, have lost or may lose competitiveness – to economic, social and civilizational degradation, and with no way out of this situation. This may disturb social and political cohesion in member countries, give birth to populist tendencies that endanger the democratic order, and hamper peaceful cooperation in Europe. The situation may get out of control and trigger a chaotic break-up of the euro zone,
threatening the future of the whole EU and Single European Market.
In order to return to the origins of European integration and avoid the chaotic break-up of the euro zone, the euro zone should be dismantled in a controlled manner. If a weak country were to leave the euro zone, it would entail panic and a banking system collapse. Therefore we opt for a different scenario, in which the euro area is slowly dismantled in such a way that the most competitive countries or group of such countries leave the euro zone. Such a step would create a new European currency regime based on national currencies or currencies serving groups of homogenous countries, and save EU institutions along with the Single European Market.
This paper has been also published in "German Economic Review" (Volume 14, Issue 1, pages 31–49, February 2013)
Authored by: Stefan Kawalec and Ernest Pytlarczyk
This paper presents an analysis of Portugal's economy from 1999 to 2015, providing an
alternative to explanations that present the situation faced by Southern European
countries after the Great Recession as a matter of excessive expenditure or loss in
competitiveness. Based upon the Sraffian Supermultiplier model, we look at how
demand components evolved along the analyzed period, in a growth accounting setting.
This assessment evidences that insufficient effective (public) demand -- not balance-ofpayments
constraints nor an alleged excess of public expenditure -- is what explains
Portugal's low-to-negative growth rates from 2001 forward. Given the limited
productive structure, a labor market that is not strong enough to guarantee a solid
internal credit expansion and the present institutional setting (which makes fiscal
expenditure an also limited source of effective demand), we conclude that the only way
for Portugal to abandon the low growth path would be a more cooperative fiscal stance
from the European Union.
Europ eco outlook 2 may 2013 hs_financelabFinanceLab
The document provides an economic and market update for Europe, with the following key points:
1) The euro crisis recovery is slow and fragile with differing speeds across countries. Germany is coping relatively well while others like Italy remain in difficult situations.
2) Financial markets have recovered somewhat on expectations of continued loose monetary policy, but the outlook remains uncertain.
3) The euro has weakened against the dollar and U.S. manufacturing, which could help the euro area recovery by boosting exports. However, long term the dollar is expected to strengthen versus the euro.
4) The European Central Bank has limited tools remaining to support growth as fiscal austerity continues to hamper a stronger recovery in many countries. The
An attempt is made to explore the basic implications of differences in productivity growth rates in countries within a monetary union and tailor them to the case of the EU new member countries running up to the EMU. By using the mathematical model of Harrod-Balassa-Samuelson effect and linking productivity and relative price dynamics with monetary policy, it is shown that: 1) productivity growth in faster-growing countries (FGC) leads to either inflation there, or union-wide exchange rate appreciation, or both in certain proportions, depending on the monetary policy stance taken by the union, but does not cause increase in inflation in slower-growing countries (SGC) by itself, unless the union’s monetary authorities take pro-inflationary policy; 2) because of presence of FGC, the SGC do not become less competitive in the world, and can benefit from increased export of their goods to FGC, provided their labour markets are flexible enough; 3) the real challenge for SGC posed by FGC is not inflation, but rather loss of jobs and export revenues, if their labour markets are not flexible enough to adjust under tight union-wide monetary policy aimed at keeping the union-wide overall price level unchanged, or the labour productivity increase in FGC is not met by adequate improvement in labour productivity in SGC. It should be noted, however, that this ‘adequate improvement’ is enough to constitute only a fraction of the productivity growth in FGC.
Authored by: Nikolai Zoubanov
Published in 2003
This document is a paper by Lubomira Anastassova titled "Institutional Arrangements of Currency Boards - Comparative Macroeconomic Analysis". The paper examines the differences in institutional frameworks for currency board arrangements across countries and assesses the impact of currency boards on macroeconomic indicators like inflation, interest rates, and economic growth. It finds that currency board countries exhibit approximately 3% lower annual inflation and 1% higher economic growth on average compared to other countries with pegged exchange rates. The paper analyzes the characteristics of currency boards, how their institutional arrangements can support successful economic development, and presents the results of a regression analysis testing the impact of currency boards on macroeconomic performance.
This document summarizes a working paper that examines the statistical properties of current account balances and their determinants across 70 countries. It finds that once regime shifts are allowed for using Markov-switching models, the null hypothesis of a unit root can be rejected for more countries than with standard linear unit root tests. The paper also investigates what country characteristics, such as exchange rate regimes, financial openness, and macroeconomic fundamentals, help explain differences in the likelihood of entering non-stationary current account regimes and in the degree of current account persistence across regimes.
This paper deals with the choice of the exchange rate parity upon Poland's entry to EMU. Given that the euro parity should reflect some equilibrium exchange rate, two theoretical concepts are discussed: fundamental and behavioural equilibrium exchange rates. These approaches are then estimated. According to these calculations, the zloty euro exchange rate in 2002 is not far from the level consistent with the current state of fundamentals (as indicted by BEER) and requires some depreciation to be in line with the equilibrium level of fundamentals (as indicated by FEER). The possible FEERs range between 3.88 and 4.08 zlotys per euro depending on the variant and REER definition. The results should be treated with great caution as they are demonstrated to be sensitive to the adopted assumptions and model specifications. It is argued that the range of "optimal" exchange rates is quiet wide. This stems from the fact that consequences of exchange rate misalignment depend primarily on its degree as well as due to the intrinsic uncertainty about empirical estimates of equilibrium exchange rate. Moreover, the scope for depreciation of the nominal zloty-euro exchange rate is limited by the ensuing costs to the economy, needs to meet Maastricht criteria, and political bargain.
Authored by: Łukasz Rawdanowicz
Published in 2002
Financial market integration and growth 2011sirio788
This document provides an introduction to a volume on financial market integration and growth in the European Union. It discusses how policy events over the last two decades have influenced the structure of financial markets among original EU members and incentives to invest in new member economies. The volume aims to study relevant European and global dynamics through chapters focusing on topics like the transatlantic banking crisis, financial market integration in the EU15, and the impact of financial development and foreign direct investment in countries like Portugal, Ireland, Greece and Spain as well as new member states. The introduction argues that new member countries represent both a geographical enlargement of the EU and a natural experiment in institutional changes and economic internationalization, providing analytical challenges to understand developments across the EU.
POSITION PAPER: Euro Zone Crisis. Diagnosis and Likely Solutions (ESADEgeo)ESADE
Author: Fernando Ballabriga
ESADEgeo - February 2014
Southern euro countries are in a situation of vulnerability due to three factors: their high debt levels, their eroded competitiveness and their difficulties to restart growth. Together, these factors generate a vicious circle which is difficult to exit and which can even degenerate into a self-fulfilling economic downward spiral. This policy brief provides a short guiding tour to the euro zone crisis. It looks at the current situation, the full context conditioning the solutions to the situation, how we got here, and the possible way out. The latter section outlines a set of minimum steps required to make the euro sustainable.
The document provides a bi-weekly market summary and analysis by Fasanara Capital. It discusses the ECB's recent policies to manually remove catalysts from the markets. It argues these policies delay necessary restructuring and add new debt on old debt. The next 6 months will be key to assess outcomes. Fasanara expects continued market resilience but is positioning portfolios with hedges for potential fat tail risks in the coming years from failing European policies.
‘European financial centres will survive the crisis’ – OPENSALON Jake Fury
The document discusses the future of European financial centers and the steps needed for financial sustainability in Europe. It argues that major European financial centers like London will survive even with relative economic decline in Europe due to factors like access to markets and qualified professionals. It also states that developing links between European and Middle Eastern financial centers could help the growth of centers in the Gulf. Finally, it claims that restoring confidence in euro-denominated government bonds through ECB support and bank capital injections will help rejuvenate European banking by reducing risk aversion among banks.
This paper is focused on the development of a proper macroeconomic strategy in the process of Poland's accession to the European Monetary Union. It is argued that due to legal and political considerations Poland may not opt out from EMU participation. The country will however command net gains from participation in the eurozone, mainly due to reduced macroeconomic and microeconomic uncertainty. In order to achieve even higher gains it is necessary to reduce price and wage rigidities, eliminate constraints on free movement of labor, further promote trade links with EU and its diversification. Loss of monetary and exchange rate instruments will require responsive but generally conservative fiscal policy. Particularly, as Poland might experience major economic upturn at the outset in the EU membership, the country should achieve positive budget balance by this time. It will allow for fiscal expansion in case of future negative asymmetric shock or recessions. Fiscal policy should be therefore assigned to improve saving-investment balance and consequently current account, so that direct inflation targeting is well placed to achieve fulfillment of Maastricht price stability criterion. Real exchange rate is not an independent instrument to target current account, as real appreciation of domestic currency is unavoidable due to rapid productivity gains in Poland. Finally, the accession to EMU should follow promptly the accession to EU. Unilateral introduction of Euro is too risky for banking and real sectors. Slower process of joining EMU would hamper credibility of macroeconomic adjustment commitment.
Authored by: Arthur Radziwill
Published in 2001
The document discusses several challenges facing the European banking industry, including low profitability, high levels of non-performing loans, overcapacity, and prospects for further bank consolidation. It notes that while bank profitability modestly improved in 2015, supported by resilient net interest income, prospects for future profitability remain uncertain given the low interest rate environment and regulatory changes. The document also examines issues like increasing competition from financial technology firms and the growth of shadow banking.
The main message of this contribution is that lean times are here to stay for the old member states. The main reasons are deep seated: Deteriorating demographics continue with ratio of working age population to total population falling. There are thus fewer and fewer producers for every consumer and recipient of transfers. On top of this productivity growth is declining as labour quality is falling and investment growth slowing. In the new member countries the demographic trends also unfavourable, but they are (more than) compensated by catch up growth as a relatively well educated work force finds its place in the internal market.
What does this diagnosis imply for the role of structural policies? No Lisbon agenda change demographics trends, nor can it change the declining capital/labour ratio due to insufficient investment growth. But structural reforms might counteract the impact of these two negative trends. Moreover, the performance gap between big and small member countries suggests that policy can make a difference.
Authored by: Daniel Gros
Published in 2005
Latvia is expected to adopt the euro on January 1, 2014. There are high expectations that adopting the euro will lead to benefits like low inflation, high growth, and rising foreign investment. However, other eurozone countries' experiences show that underlying competitiveness, institutions, politics, and policymaking are more important determinants of success than joining criteria. Slovenia joined the eurozone in 2007 and experienced slowing growth as it struggled with institutional readiness. Slovakia joined in 2009 at an overvalued exchange rate but was able to avoid major negative impacts due to previous economic reforms. Estonia's transition to the euro in 2011 went smoothly.
The majority of respondents expect the following:
1) The EU economy will experience low growth in the next two years, with amend & extend and debt buybacks being the most prevalent forms of debt renegotiation.
2) The volume of European restructurings will peak in the second half of 2015 or first half of 2016.
3) Between 10-20% of sub-investment grade companies will face debt restructurings in 2015, marking an increase over 2014.
4) Most debt restructurings will originate from Southern Europe, particularly Italy and Spain.
This document discusses attracting international investment to boost economic growth in the EU. It presents three case studies:
1) A survey of Swiss SMEs found their main concern when investing internationally is time-consuming bureaucracy. Despite limited capital market use, 20% see the EU common capital market as important.
2) Private investors can help fund long-term projects like infrastructure. EU policies should encourage private investment through enhanced regulation, better taxation, and streamlined alternative investment registration and distribution.
3) UK infrastructure case studies show public-private partnerships can fund projects through innovative financing like contingent guarantees. The IMF argues infrastructure investment can stimulate growth.
The financial innovations and increased integration of capital markets have made the nature of balance of payments turmoil much more complex, than described by firstgeneration models. The severe financial crises, which erupted in 1990's in many seemingly "invulnerable" economies that in most cases were characterised by a balanced budget and a modest public debt have turned away the attention of analysts and policymakers from fiscal variables towards other determinants. The fiscal factors, nonetheless, still remain among important causes of financial turbulences, especially in emerging markets, what has been manifested by the 1998/1999 crises of FSU (Former Soviet Union) economies.
The purpose of this paper is to re-examine the theoretical and empirical links between fiscal sector and the emergence of financial crises, with an emphasis on transition economies.
Authored by: Joanna Siwinska-Gorzelak
Published in 2000
This document provides a summary of economic and political developments in several European countries. It discusses unemployment rates, GDP growth, public spending changes, sovereign debt ratings, and other economic indicators in countries such as Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, and France. The document is an economic recovery watch report from the Centre For European Studies that briefly outlines recent news and statistics from EU member states.
This seminar, hosted jointly by the British Embassy and Afi School of Finance, was aimed at companies seeking alternative financing, as well as investors looking for new investment opportunities. It was also of interest to government officials and regulators.
Presentation delivered by prof. Marc Pagano during 132nd mBank - CASE Seminar "Is Europe Overbanked?" (17.06.2014)
http://www.case-research.eu/en/node/58561
The document is the ECB's October 2014 Banking Structures Report. It summarizes that in 2013:
- The number of credit institutions in the euro area continued to decline from 6,100 in 2012 to 5,948 as consolidation in the banking sector continued, driven by cost-cutting pressures.
- Market concentration in the euro area banking sector increased compared to pre-crisis levels, though there was heterogeneity across countries.
- Total assets of euro area banks declined to €26.8 trillion from €29.6 trillion in 2012, largely due to deleveraging by large banks through reducing non-core assets and derivatives.
This document discusses the controlled dismantlement of the euro area in order to preserve the European Union and single market. It argues that remaining in the eurozone may condemn some countries that have lost competitiveness to economic and social degradation without an exit. This could undermine political and social cohesion and give rise to populism. To avoid a chaotic breakup, the eurozone should be dismantled in a controlled manner by competitive countries leaving first to form a new currency regime of national currencies or currency blocs. This would save the EU and single market.
Target balances of eurozone national central banks nber wp17626 sinn_wollmneiracar
This document summarizes a working paper about Target loans, current account balances, and capital flows within the European Central Bank's (ECB) rescue facility. It finds that the accumulated Target balances in national central banks, which totaled €404 billion in August 2011 for Greece, Ireland, Italy, Portugal and Spain, have essentially functioned as balance of payments deficits and surpluses. To finance the deficits, the ECB allowed significant money creation and lending by peripheral national central banks, shifting the stock of refinancing credit from core countries like Germany to the periphery. This public capital flow through the ECB system helped crisis countries before formal euro rescue facilities and bypassed European parliaments. Target credits financed almost all of Portugal and
This paper draws on the experience of emerging Europe and argues that foreign capital is an enviable development opportunity with tail risks. Financial integration and foreign savings supported growth in the EU12 and EU candidate countries. We argue that this was possible because of EU membership (actual or potential) and its role as an anchor for expectations. In contrast, the eastern partnership states did not benefit from the foreign savings-growth link. But financial integration also led to a buildup of vulnerabilities and now exposes emerging Europe to prolonged uncertainty and financial deleveraging due to eurozone developments. Nonetheless, we believe that external imbalances should not be eradicated—nor should emerging Europe pursue a policy of self-insurance. Instead, what we refer to as an acyclical fiscal policy stance could serve to counterbalance private sector behavior. Going forward, a more proactive macroprudential policy will also be needed to limit financial system vulnerabilities when external imbalances are large.
This paper build on work presented in a World Bank report titled “Golden Growth: Restoring the Lustre of the European Economic Model” (2012) and on Juan Zalduendo’s presentation on “Financial integration. Lessons from CEE and SEE” delivered at the CASE 2011 International Conference on “Europe 2020: Exploring the Future of European Integration” held in Falenty near Warsaw, November 18-19, 2011.
Authored by: Aleksandra Iwulska, Naotaka Sugawara, Juan Zalduendo
Published in 2012
This document analyzes economic growth and determining factors in Hungary and Ukraine. It finds that Central and Eastern Europe has not finished transition and is trending toward the Southern European periphery crisis. The authors introduce a new production function identifying bottlenecks as organizational and human capital not meeting needs of large companies. Both countries are postponing long-term investments like human capital due to present crisis, exacerbating issues.
This document provides a 3-paragraph summary of a policy brief on the current state of the European Union. It begins by outlining the economic advantages of adopting a single currency, such as reduced transaction costs and exchange rate uncertainty. However, it notes that more economic and fiscal integration is needed to ensure long-term success. The document then presents an action plan to strengthen economic governance and establish a European Debt Agency. It argues that growth is also important to overcoming the crisis. In conclusion, the policy brief advocates bold action to take advantage of the crisis and overcome current challenges facing the European Union.
This document provides a 3-paragraph summary of a policy brief on the current state of the European Union. It begins by outlining the economic advantages of adopting a single currency, such as reduced transaction costs and exchange rate uncertainty. However, it notes that more economic and fiscal integration is needed to ensure long-term success. The document then presents an action plan to strengthen economic governance and establish a European Debt Agency. It argues that growth is also important to overcoming the crisis. In conclusion, the policy brief advocates bold action to take advantage of the crisis and overcome current challenges facing the European Union.
This paper deals with the choice of the exchange rate parity upon Poland's entry to EMU. Given that the euro parity should reflect some equilibrium exchange rate, two theoretical concepts are discussed: fundamental and behavioural equilibrium exchange rates. These approaches are then estimated. According to these calculations, the zloty euro exchange rate in 2002 is not far from the level consistent with the current state of fundamentals (as indicted by BEER) and requires some depreciation to be in line with the equilibrium level of fundamentals (as indicated by FEER). The possible FEERs range between 3.88 and 4.08 zlotys per euro depending on the variant and REER definition. The results should be treated with great caution as they are demonstrated to be sensitive to the adopted assumptions and model specifications. It is argued that the range of "optimal" exchange rates is quiet wide. This stems from the fact that consequences of exchange rate misalignment depend primarily on its degree as well as due to the intrinsic uncertainty about empirical estimates of equilibrium exchange rate. Moreover, the scope for depreciation of the nominal zloty-euro exchange rate is limited by the ensuing costs to the economy, needs to meet Maastricht criteria, and political bargain.
Authored by: Łukasz Rawdanowicz
Published in 2002
Financial market integration and growth 2011sirio788
This document provides an introduction to a volume on financial market integration and growth in the European Union. It discusses how policy events over the last two decades have influenced the structure of financial markets among original EU members and incentives to invest in new member economies. The volume aims to study relevant European and global dynamics through chapters focusing on topics like the transatlantic banking crisis, financial market integration in the EU15, and the impact of financial development and foreign direct investment in countries like Portugal, Ireland, Greece and Spain as well as new member states. The introduction argues that new member countries represent both a geographical enlargement of the EU and a natural experiment in institutional changes and economic internationalization, providing analytical challenges to understand developments across the EU.
POSITION PAPER: Euro Zone Crisis. Diagnosis and Likely Solutions (ESADEgeo)ESADE
Author: Fernando Ballabriga
ESADEgeo - February 2014
Southern euro countries are in a situation of vulnerability due to three factors: their high debt levels, their eroded competitiveness and their difficulties to restart growth. Together, these factors generate a vicious circle which is difficult to exit and which can even degenerate into a self-fulfilling economic downward spiral. This policy brief provides a short guiding tour to the euro zone crisis. It looks at the current situation, the full context conditioning the solutions to the situation, how we got here, and the possible way out. The latter section outlines a set of minimum steps required to make the euro sustainable.
The document provides a bi-weekly market summary and analysis by Fasanara Capital. It discusses the ECB's recent policies to manually remove catalysts from the markets. It argues these policies delay necessary restructuring and add new debt on old debt. The next 6 months will be key to assess outcomes. Fasanara expects continued market resilience but is positioning portfolios with hedges for potential fat tail risks in the coming years from failing European policies.
‘European financial centres will survive the crisis’ – OPENSALON Jake Fury
The document discusses the future of European financial centers and the steps needed for financial sustainability in Europe. It argues that major European financial centers like London will survive even with relative economic decline in Europe due to factors like access to markets and qualified professionals. It also states that developing links between European and Middle Eastern financial centers could help the growth of centers in the Gulf. Finally, it claims that restoring confidence in euro-denominated government bonds through ECB support and bank capital injections will help rejuvenate European banking by reducing risk aversion among banks.
This paper is focused on the development of a proper macroeconomic strategy in the process of Poland's accession to the European Monetary Union. It is argued that due to legal and political considerations Poland may not opt out from EMU participation. The country will however command net gains from participation in the eurozone, mainly due to reduced macroeconomic and microeconomic uncertainty. In order to achieve even higher gains it is necessary to reduce price and wage rigidities, eliminate constraints on free movement of labor, further promote trade links with EU and its diversification. Loss of monetary and exchange rate instruments will require responsive but generally conservative fiscal policy. Particularly, as Poland might experience major economic upturn at the outset in the EU membership, the country should achieve positive budget balance by this time. It will allow for fiscal expansion in case of future negative asymmetric shock or recessions. Fiscal policy should be therefore assigned to improve saving-investment balance and consequently current account, so that direct inflation targeting is well placed to achieve fulfillment of Maastricht price stability criterion. Real exchange rate is not an independent instrument to target current account, as real appreciation of domestic currency is unavoidable due to rapid productivity gains in Poland. Finally, the accession to EMU should follow promptly the accession to EU. Unilateral introduction of Euro is too risky for banking and real sectors. Slower process of joining EMU would hamper credibility of macroeconomic adjustment commitment.
Authored by: Arthur Radziwill
Published in 2001
The document discusses several challenges facing the European banking industry, including low profitability, high levels of non-performing loans, overcapacity, and prospects for further bank consolidation. It notes that while bank profitability modestly improved in 2015, supported by resilient net interest income, prospects for future profitability remain uncertain given the low interest rate environment and regulatory changes. The document also examines issues like increasing competition from financial technology firms and the growth of shadow banking.
The main message of this contribution is that lean times are here to stay for the old member states. The main reasons are deep seated: Deteriorating demographics continue with ratio of working age population to total population falling. There are thus fewer and fewer producers for every consumer and recipient of transfers. On top of this productivity growth is declining as labour quality is falling and investment growth slowing. In the new member countries the demographic trends also unfavourable, but they are (more than) compensated by catch up growth as a relatively well educated work force finds its place in the internal market.
What does this diagnosis imply for the role of structural policies? No Lisbon agenda change demographics trends, nor can it change the declining capital/labour ratio due to insufficient investment growth. But structural reforms might counteract the impact of these two negative trends. Moreover, the performance gap between big and small member countries suggests that policy can make a difference.
Authored by: Daniel Gros
Published in 2005
Latvia is expected to adopt the euro on January 1, 2014. There are high expectations that adopting the euro will lead to benefits like low inflation, high growth, and rising foreign investment. However, other eurozone countries' experiences show that underlying competitiveness, institutions, politics, and policymaking are more important determinants of success than joining criteria. Slovenia joined the eurozone in 2007 and experienced slowing growth as it struggled with institutional readiness. Slovakia joined in 2009 at an overvalued exchange rate but was able to avoid major negative impacts due to previous economic reforms. Estonia's transition to the euro in 2011 went smoothly.
The majority of respondents expect the following:
1) The EU economy will experience low growth in the next two years, with amend & extend and debt buybacks being the most prevalent forms of debt renegotiation.
2) The volume of European restructurings will peak in the second half of 2015 or first half of 2016.
3) Between 10-20% of sub-investment grade companies will face debt restructurings in 2015, marking an increase over 2014.
4) Most debt restructurings will originate from Southern Europe, particularly Italy and Spain.
This document discusses attracting international investment to boost economic growth in the EU. It presents three case studies:
1) A survey of Swiss SMEs found their main concern when investing internationally is time-consuming bureaucracy. Despite limited capital market use, 20% see the EU common capital market as important.
2) Private investors can help fund long-term projects like infrastructure. EU policies should encourage private investment through enhanced regulation, better taxation, and streamlined alternative investment registration and distribution.
3) UK infrastructure case studies show public-private partnerships can fund projects through innovative financing like contingent guarantees. The IMF argues infrastructure investment can stimulate growth.
The financial innovations and increased integration of capital markets have made the nature of balance of payments turmoil much more complex, than described by firstgeneration models. The severe financial crises, which erupted in 1990's in many seemingly "invulnerable" economies that in most cases were characterised by a balanced budget and a modest public debt have turned away the attention of analysts and policymakers from fiscal variables towards other determinants. The fiscal factors, nonetheless, still remain among important causes of financial turbulences, especially in emerging markets, what has been manifested by the 1998/1999 crises of FSU (Former Soviet Union) economies.
The purpose of this paper is to re-examine the theoretical and empirical links between fiscal sector and the emergence of financial crises, with an emphasis on transition economies.
Authored by: Joanna Siwinska-Gorzelak
Published in 2000
This document provides a summary of economic and political developments in several European countries. It discusses unemployment rates, GDP growth, public spending changes, sovereign debt ratings, and other economic indicators in countries such as Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, and France. The document is an economic recovery watch report from the Centre For European Studies that briefly outlines recent news and statistics from EU member states.
This seminar, hosted jointly by the British Embassy and Afi School of Finance, was aimed at companies seeking alternative financing, as well as investors looking for new investment opportunities. It was also of interest to government officials and regulators.
Presentation delivered by prof. Marc Pagano during 132nd mBank - CASE Seminar "Is Europe Overbanked?" (17.06.2014)
http://www.case-research.eu/en/node/58561
The document is the ECB's October 2014 Banking Structures Report. It summarizes that in 2013:
- The number of credit institutions in the euro area continued to decline from 6,100 in 2012 to 5,948 as consolidation in the banking sector continued, driven by cost-cutting pressures.
- Market concentration in the euro area banking sector increased compared to pre-crisis levels, though there was heterogeneity across countries.
- Total assets of euro area banks declined to €26.8 trillion from €29.6 trillion in 2012, largely due to deleveraging by large banks through reducing non-core assets and derivatives.
This document discusses the controlled dismantlement of the euro area in order to preserve the European Union and single market. It argues that remaining in the eurozone may condemn some countries that have lost competitiveness to economic and social degradation without an exit. This could undermine political and social cohesion and give rise to populism. To avoid a chaotic breakup, the eurozone should be dismantled in a controlled manner by competitive countries leaving first to form a new currency regime of national currencies or currency blocs. This would save the EU and single market.
Target balances of eurozone national central banks nber wp17626 sinn_wollmneiracar
This document summarizes a working paper about Target loans, current account balances, and capital flows within the European Central Bank's (ECB) rescue facility. It finds that the accumulated Target balances in national central banks, which totaled €404 billion in August 2011 for Greece, Ireland, Italy, Portugal and Spain, have essentially functioned as balance of payments deficits and surpluses. To finance the deficits, the ECB allowed significant money creation and lending by peripheral national central banks, shifting the stock of refinancing credit from core countries like Germany to the periphery. This public capital flow through the ECB system helped crisis countries before formal euro rescue facilities and bypassed European parliaments. Target credits financed almost all of Portugal and
This paper draws on the experience of emerging Europe and argues that foreign capital is an enviable development opportunity with tail risks. Financial integration and foreign savings supported growth in the EU12 and EU candidate countries. We argue that this was possible because of EU membership (actual or potential) and its role as an anchor for expectations. In contrast, the eastern partnership states did not benefit from the foreign savings-growth link. But financial integration also led to a buildup of vulnerabilities and now exposes emerging Europe to prolonged uncertainty and financial deleveraging due to eurozone developments. Nonetheless, we believe that external imbalances should not be eradicated—nor should emerging Europe pursue a policy of self-insurance. Instead, what we refer to as an acyclical fiscal policy stance could serve to counterbalance private sector behavior. Going forward, a more proactive macroprudential policy will also be needed to limit financial system vulnerabilities when external imbalances are large.
This paper build on work presented in a World Bank report titled “Golden Growth: Restoring the Lustre of the European Economic Model” (2012) and on Juan Zalduendo’s presentation on “Financial integration. Lessons from CEE and SEE” delivered at the CASE 2011 International Conference on “Europe 2020: Exploring the Future of European Integration” held in Falenty near Warsaw, November 18-19, 2011.
Authored by: Aleksandra Iwulska, Naotaka Sugawara, Juan Zalduendo
Published in 2012
This document analyzes economic growth and determining factors in Hungary and Ukraine. It finds that Central and Eastern Europe has not finished transition and is trending toward the Southern European periphery crisis. The authors introduce a new production function identifying bottlenecks as organizational and human capital not meeting needs of large companies. Both countries are postponing long-term investments like human capital due to present crisis, exacerbating issues.
This document provides a 3-paragraph summary of a policy brief on the current state of the European Union. It begins by outlining the economic advantages of adopting a single currency, such as reduced transaction costs and exchange rate uncertainty. However, it notes that more economic and fiscal integration is needed to ensure long-term success. The document then presents an action plan to strengthen economic governance and establish a European Debt Agency. It argues that growth is also important to overcoming the crisis. In conclusion, the policy brief advocates bold action to take advantage of the crisis and overcome current challenges facing the European Union.
This document provides a 3-paragraph summary of a policy brief on the current state of the European Union. It begins by outlining the economic advantages of adopting a single currency, such as reduced transaction costs and exchange rate uncertainty. However, it notes that more economic and fiscal integration is needed to ensure long-term success. The document then presents an action plan to strengthen economic governance and establish a European Debt Agency. It argues that growth is also important to overcoming the crisis. In conclusion, the policy brief advocates bold action to take advantage of the crisis and overcome current challenges facing the European Union.
This document summarizes key findings from the first wave of the Eurosystem Household Finance and Consumption Survey (HFCS) regarding household finances in 15 euro area countries. Some key points:
- Households own their main residence, deposits, and private pensions most commonly, while ownership of other assets varies substantially across countries. Real estate makes up most of household assets.
- Over half of households have no debt, but mortgage and non-mortgage debt prevalence differs across countries. Median mortgage debt exceeds median non-mortgage debt.
- Median net wealth of euro area households is €109,200, but there is wide cross-country variation. Wealth is concentrated among older households while younger households tend
This document provides an overview of the financial system of the enlarged European Union (EU) with 25 member states. It describes the development of financial systems in EU countries since 1995 and compares structures between old and new member states. Key differences are documented between new and old members, with new members generally having less developed financial systems. The document also briefly compares EU financial structures to those of the US and Japan.
The document discusses Europe's fragmented bond markets, which have become more divided during the euro crisis. Government bond yields have varied widely between member states, making fiscal adjustment difficult for countries with high borrowing costs and slowing economic growth. While market differentiation pressures fiscal discipline, the current level of variance is unsustainable. Integrating Europe's bond markets into a large, unified market could help overcome difficulties by creating more liquidity and lowering interest rates, but this cannot undermine budget constraints for highly indebted countries.
This paper confronts the traditional balance-of-payments (BoP) analytical framework (with its dominant focus on the size of a given country’s current account imbalance and its external liabilities) with the contemporary realities of highly integrated international capital markets and cross-country capital mobility. Some key implicit assumptions of the traditional framework like those of a fixed residence of capital owners and home country bias are challenged and an alternative set of assumptions is offered. These reflect the unrestricted character of private capital flows (with no “home country bias” and fixed domicile) determined mostly by the expected rate of return. As a result, the importance of BoP constraints (in their “orthodox” interpretation) diminishes and they disappear completely with respect to individual member states within a highly integrated monetary union. This does not mean, however, immunization from other kinds of macroeconomic risks.
Authored by: Marek Dąbrowski
Published in 2006
This paper reports the progress of nominal and real convergence of Spain, Portugal and Greece during their accession to the Economic and Monetary Union (EMU). When the EMU was designed, it was hoped that it would induce nominal convergence (convergence of interest rates and inflation rates) and stimulate investments and economic growth through its positive microeconomic effects. As had been expected, nominal interest rates have converged quite early during the accession, output has been growing fast, and the countries experienced an inflow of foreign direct investments (FDI) and an increase of domestic investment rates. However, once within the EMU, all three countries experienced persistently higher inflation rates, which may be consistent with the convergence of price levels, instead of inflation. While all the above phenomena can be related to the EMU accession, in an econometric estimation for Spain in which we control for macroeconomic policies, we are unable to detect significant microeconomic effects of the EMU. Therefore, we conclude that it is the policies induced by the necessity to satisfy the Maastricht criteria that matter primarily for the macroeconomic performance soon after accession. In any case, the experience of the SPG is encouraging for the new member states facing accession to the EMU in the future.
Authored by: Marek Jarocinski
Published in 2003
This paper discusses the global financial crisis of 2008/9 in thirteen countries, the ten new EU members that previously were communist and the three countries of Western former Soviet Union. Their problems were excessive current account deficits and private foreign debt, currency mismatches, and high inflation, while public finances were in good shape. The dominant cause was fixed exchange rates. Many lessons can be drawn from this crisis. A dollar peg makes no sense in this part of the world. The five currency boards in the region have lacked credibility. By contrast, inflation targeting has worked eminently. The euro has proven credible both in the countries that officially adopted it and in the countries that adopted it unilaterally. With the exception of Hungary, all the countries in the region have displayed decent fiscal policies. No government should accept large domestic loans in foreign currency and they can be regulated away. The IMF has successfully returned to the original Washington consensus with relatively few conditions: a reasonable budget balance and a realistic exchange rate policy, while focusing more on bank restructuring. The most controversial issue is the role of the ECB. The ECB should facilitate the accession of willing EU members to the euro by relaxing the ERM II conditions.
Authored by: Anders Aslund
Published in 2009
Harvard Kennedy School: Eurozone Study Jan. 2017 chaganomics
This document summarizes a paper that examines the resilience of the Eurozone in the face of crises. Deep financial integration created interdependence among Eurozone members, providing mechanisms to reallocate resources and absorb economic shocks. Global market pressures forced political leaders to reinforce the monetary union through fiscal and monetary backstops. Ongoing progress on banking supervision and regulation has further strengthened the currency union. While the Eurozone still falls short as an optimal currency area, financial integration may drive further integration through banking reforms, even amid populist opposition to other reforms.
The paper presents new results on within-country regional inequality in per capita income for 36 countries during 1995-2005; focusing on Europe but with some non-European countries included for comparison. In 23 of the 36 countries there was a significant increase in regional inequality during the period, and in only three cases there was a reduction. Regional inequality increased in all countries of Central and Eastern Europe, while for most Western European countries there was little change. For the EU-27 as a whole, there was a modest increase in within-country regional inequality, but convergence across countries. The latter effect was quantitatively more important, so on the whole there was income convergence in the EU-27, especially after 2000. Regional inequality is particularly important for some large middle-income countries such as China, Russia and Mexico. In such countries there may however be considerable price differences across regions, and the use of common price deflators for the whole country may lead to a biased assessment of regional inequality.
Authored by: Arne Melchior
Published in 2008
The paper first considers why central European countries wish to join EMU soon. The main reasons are the risk of macroeconomic instability they face outside the euro zone if they wish to grow quickly. At the same time, Central Europe is highly integrated as regards trade with EMU, so it is little exposed to asymmetric shocks that would require a realignment of exchange rates. Finally, it is argued that there is no cost in terms of slower growth from EMU accession, so that there is no trade-off, as has been claimed, between nominal convergence to EMU and real convergence to EU average GDP levels. Second, the paper assesses whether Central European accession to EMU would be disadvantageous to current members. It concludes that accession cannot increase inflationary pressure on existing EMU members, as has been claimed, but that slow growing members of EMU might suffer increased unemployment, unless they increase the flexibility of their labour markets. Incumbent members may also be unwilling to share power with Central Europeans in EMU institutions.
Authored by: Jacek Rostowski
Published in 2003
The purpose of this paper is to look at implications of the EMU accession on international trade flows of the new member states with members of the enlarged EU. I begin with the evaluation of an early impact of the EMU on trade based on a gravity model. The results are then employed in the calculation of potential levels of trade of the Central and East European countries. The results show a high degree of trade integration between most of the new member states and the EU except for Latvia, Lithuania and Poland. In trade among the new member states, potential trade flows by far exceed actual levels for all countries except the Czech Republic and Slovakia.
Authored by: Maryla Maliszewska
Published in 2004
Effect of Euro on Income_Econometric PaperPatrick Hess
The document analyzes the economic impact of adopting the euro as a common currency on average income levels. Using panel data from 16 European countries from 1985-2005, the study finds that adopting the euro has had a statistically significant negative effect on average income. Specifically, the analysis shows that average income was $635 lower per year for countries that adopted the euro. Additionally, the negative impact was largest one year after adoption, with income $743-$1,006 lower. The study also finds the negative effect was greater for highly urbanized eurozone countries, possibly due to increased dependence on exporting outside the eurozone.
We use newly compiled top income share data and structural breaks techniques to estimate common trends and breaks in inequality across countries over the twentieth century. Our results both confirm earlier findings and offer new insights. In particular, the division into an Anglo-Saxon and a Continental European experience is not as clear cut as previously suggested. Some Continental European countries seem to have experienced increases in top income shares, just as Anglo-Saxon countries, but typically with a lag. Most notably, Nordic countries display a marked “Anglo-Saxon” pattern, with sharply increased top income shares especially when including realized capital gains. Our results help inform theories about the causes of the recent rise in inequality.
This document summarizes changes in the economic geography of Europe from 1995-2005 based on regional income data from 29 countries. It finds that domestic regional inequality increased substantially in eastern Europe, while central Europe saw little change or reductions in inequality. Darker shaded areas on the map indicate higher increases in regional disparities. The analysis focuses on exploring the east-west dimension of economic development on the continent and how international integration affects regions within countries.
This paper analyses the effect of the EU enlargement process on income convergence among regions in the EU and in the Eastern neighbourhood of the EU. The data used is NUTS II regions in the EU and Oblasts' of Russia over the period 1996-2004. The estimation techniques used take into account both regional and spatial heterogeneity. The main findings are that the regional income differences are reduced within EU15. The income convergence within the EU is mainly driven by reductions in the differences across countries rather than by a reduction in regional differences within countries. When differences in initial conditions in the regions are controlled for by fixed regional effects there are strong evidences of convergence among regions in all studied country groups.
Authored by: Fredrik Wilhelmsson
Published in 2009
Similar to CASE Network Studies and Analyses 345 - Current Account Imbalances in the Euro Area (draft version) (20)
The report examines the social and economic drivers and impact of circular migration between Belarus and Poland, Slovakia, and the Czech Republic. The core question the authors sought to address was how managing circular migration could, in the long term, help to optimise labour resources in both the country of origin and the destination countries. In the pages that follow, the authors of the report present the current and forecasted labour market and demographic situation in their respective countries as well as the dynamics and characteristics of short-term labour migration flows between Belarus and Poland, Slovakia, and the Czech Republic, concentrating on the period since 2010. They also outline and discuss related policy responses and evaluate prospects for cooperation on circular migration.
Podręcznik został opracowany w celu przekazania trenerom i nauczycielom podstawowej wiedzy, która może być przydatna w prowadzeniu szkoleń promujących pracę rejestrowaną. Prezentuje on z jednej strony korzyści z pracy rejestrowanej, z drugiej – potencjalne koszty związane z pracą nierejestrowaną. W pierwszej kolejności informacje te przedstawiono w odniesieniu do pracowników najemnych (rozdział 2), podkreślając w sposób szczególny to, że negatywne konsekwencje pracy nierejestrowanej są ponoszone przez całe życie. Ze względu na specyficzną sytuację cudzoziemców pracujących w Polsce konsekwencje ponoszone przez tę grupę opisano oddzielnie (rozdział 3). Ponadto zaprezentowano skutki dotyczące pracodawców z szarej strefy z wyodrębnieniem tych, którzy zatrudniają cudzoziemców (rozdział 4). Uzupełnieniem przedstawionych informacji jest opis działań podejmowanych przez państwo w celu ograniczenia zjawiska pracy nierejestrowanej w Polsce (rozdział 5) oraz prowadzonych w Wielkiej Brytanii, czyli w kraju będącym liderem w walce z szarą strefą (rozdział 6).
European countries face a challenge related to the economic and social consequences of their societies’ aging. Specifically, pension systems must adjust to the coming changes, maintaining both financial stability, connected with equalizing inflows from premiums and spending on pensions, and simultaneously the sufficiency of benefits, protecting retirees against poverty and smoothing consumption over their lives, i.e. ensuring the ability to pay for consumption needs at each stage of life, regardless of income from labor.
One of the key instruments applied toward these goals is the retirement age. Formally it is a legally established boundary: once people have crossed it – on average – they significantly lose their ability to perform work (the so-called old-age risk). But since the 1970s, in many developed countries the retirement age has become an instrument of social and labor-market policy. Specifically, in the 1970s and ‘80s, an early retirement age was perceived as a solution allowing a reduction in the supply of labor, particularly among people with relatively low competencies who were approaching retirement age, which is called the lump of labor fallacy. It was often believed that people taking early retirement freed up jobs for the young. But a range of economic evidence shows that the number of jobs is not fixed, and those who retire don’t in fact free up jobs. On the contrary, because of higher spending by pension systems, labor costs rise, which limits the supply of jobs. In general, a good situation on the labor market supports employment of both the youngest and the oldest labor force participants. Additionally, a lower retirement age for women was maintained, which resulted to a high degree from cultural conditions and norms that are typical for traditional societies.
Until now, the banking sector has been one of the strong points of Poland’s economy. In contrast to banks in the U.S. and leading Western European economies, lenders in Poland came through the 2008 global financial crisis without a scratch, without needing state financial support. But in recent years the industry’s problems have been growing, creating a threat to economic growth and gains in living standards.
For an economy’s productivity to increase, funds can’t go to all companies evenly, and definitely shouldn’t go to those that are most lacking in funds, but to those that will use them most efficiently. This is true of total external financing, and thus funding both from the banking sector and from parabanks, the capital market and funds from public institutions. In Poland, in light of the relatively modest scale of the capital market, banks play a clearly dominant role in external financing of companies. This is why the author of this text focuses on the bank credit allocation efficiency.
The author points out that in the very near future, conditions will emerge in Poland which – as the experience of other countries shows – create a risk of reduced efficiency of credit allocation to business. Additionally, in Poland today, bank lending to companies is to a high degree being replaced by funds from state aid, which reduces the efficiency of allocation of external funds to companies (both loans and subsidies), as allocation of government subsidies is not usually based on efficiency. This decline in external financing allocation efficiency may slow, halt or even reverse the process, that has been uninterrupted for 28 years, of Poland’s convergence, i.e. the narrowing of the gap in living standards between Poland and the West.
The economic characteristics of the COVID-19 crisis differ from those of previous crises. It is a combination of demand- and supply-side constraints which led to the formation of a monetary overhang that will be unfrozen once the pandemic ends. Monetary policy must take this effect into consideration, along with other pro-inflationary factors, in the post-pandemic era. It must also think in advance about how to avoid a policy trap coming from fiscal dominance.
This paper is organized as follows: Chapter 2 deals with the economic characteristics of the COVID-19 pandemic and its impact on the effectiveness of the monetary policy response measures undertaken. In Chapter 3, we analyse the monetary policy decisions of the ECB (and other major CBs for comparison) and their effectiveness in achieving the declared policy goals in the short term. Chapter 4 is devoted to an analysis of the policy challenges which may be faced by the ECB and other major CBs once the pandemic emergency comes to its end. Chapter 5 contains a summary and the conclusions of our analysis.
Purpose: This paper tries to identify the wage gap between informal and formal workers and tests for the two-tier structure of the informal labour market in Poland.
Design/methodology/approach: I employ the propensity score matching (PSM) technique and use data from the Polish Labour Force Survey (LFS) for the period 2009–2017 to estimate the wage gap between informal and formal workers, both at the means and along the wage distribution. I use two definitions of informal employment: a) employment without a written agreement and b) employment while officially registered as unemployed at a labour office. In order to reduce the bias resulting from the non-random selection of
individuals into informal employment, I use a rich set of control variables representing several individual characteristics.
Findings: After controlling for observed heterogeneity, I find that on average informal workers earn less than formal workers, both in terms of monthly earnings and hourly wage. This result is not sensitive to the definition of informal employment used and is
stable over the analysed time period (2009–2017). However, the wage penalty to informal employment is substantially higher for individuals at the bottom of the wage distribution, which supports the hypothesis of the two-tier structure of the informal labour market in Poland.
Originality/value: The main contribution of this study is that it identifies the two-tier structure of the informal labour market in Poland: informal workers in the first quartile of the wage distribution and those above the first quartile appear to be in two partially different segments of the labour market.
This document provides a comparative analysis of the rule of law and its impact on economic development in Poland and Germany. It finds that while both countries have strong rule of law frameworks de jure, there are significant differences de facto, with Polish firms showing less trust in the state and courts compared to German firms. Empirical analysis suggests higher levels of investment and economic development in Germany can be partially attributed to firms' greater recognition of the rule of law's ability to reduce transaction costs. Erosion of the rule of law in Poland since 2015 has likely negatively impacted investment and capital accumulation compared to Germany.
The report analyzes the VAT gap in the EU-28 member states in 2018. It finds that the total VAT gap in the EU was an estimated €137 billion, representing 12.2% of the total VAT liability. This is an increase compared to 2017, when the gap was €117 billion or 11.2% of the total liability. The report examines VAT revenue, total VAT liability, and VAT gap estimates for each member state from 2014 to 2018. It also conducts econometric analysis to identify factors influencing VAT gap levels across countries.
The euro is the second most important global currency after the US dollar. However, its international role has not increased since its inception in 1999. The private sector prefers using the US dollar rather than the euro because the financial market for US dollar-denominated assets is larger and deeper; network externalities and inertia also play a role. Increasing the attractiveness of the euro outside the euro area requires, among others, a proactive role for the European Central Bank and completing the Banking Union and Capital Market Union.
Forecasting during a strong shock is burdened with exceptionally high uncertainty. This gives rise to the temptation to formulate alarmist forecasts. Experiences from earlier pandemics, particularly those from the 20th century, for which we have the most data, don’t provide a basis for this. The mildest of them weakened growth by less than 1 percentage point, and the worst, the Spanish Flu, by 6 percentage points. Still, even the Spanish Flu never caused losses on the order of 20% of GDP – not even where it turned out to be a humanitarian disaster, costing the lives of 3-5% of the population. History suggests that if pandemics lead to such deep losses at all, it’s only in particular quarters and not over a whole year, as economic activity rebounds. The strength of that rebound is largely determined by economic policy. The purpose of this work is to describe possible scenarios for a rebound in Polish economic growth after the epidemic.
A separate issue, no less important, is what world will emerge from the current crisis. In the face of the 2008 financial crisis, White House Chief of Staff Rahm Emanuel said: “You never want a serious crisis to go to waste. And what I mean by that is an opportunity to do things that you think you could not do before.” Such changes can make the economy and society function better than before the crisis. Unfortunately, the opportunities created by the global financial crisis were squandered. Today’s task is more difficult; the scale of various problems has expanded even more. Without deep structural and institutional changes, the world will be facing enduring social and economic problems, accompanied by long-term stagnation.
"Many brilliant prophecies have appeared for the future of the EU and our entire planet. I believe that Europe, in its own style, will draw pragmatic conclusions from the crisis, not revolutionary ones; conclusions that will allow us to continue enjoying a Europe without borders. Brussels will demonstrate its usefulness; it will react ably and flexibly. First of all, contrary to the deceitful statements of members of the Polish government, the EU warned of the threats already in 2021. Secondly, already in mid-March EU assistance programs were ready, i.e. earlier than the PiS government’s “shield” program. The conclusion from the crisis will be a strengthening of all the preventive mechanisms that allow us to recognize threats and react in time of need. Research programs will be more strongly directed toward diagnosing and treating infectious diseases. Europe will gain greater self-sufficiency in the area of medical equipment and drugs, and the EU – greater competencies in the area of the health service, thus far entrusted to the member states. The 2021-27 budget must be reconstructed, to supplement the priority of the Green Deal with economic stimulus programs. In this way structural funds, which have the greatest multiplier effect for investment and the labor market, may return to favor. So once again: an addition, as a conclusion from the crisis, and not a reinvention of the EU," writes Dr. Janusz Lewandowski the author of the 162nd mBank-CASE seminar Proceeding.
Dla wielu rodaków europejskość Polski jest oczywista, trudno jest im nawet wyobrazić sobie, jak kształtowałyby się losy naszego kraju bez uczestnictwa w integracji europejskiej. Szczególnie młode pokolenie traktuje osiągnięty przez nas dzięki uczestnictwie w Unii ogromny postęp cywilizacyjny jako coś danego i naturalnego. Jednak świadomość tego, jaki był nasz punkt wyjścia, jaką przeszliśmy drogę i jak przyczyniły się do tego unijne działania oraz jakie wynikały z tego korzyści powinna nam stale towarzyszyć. Bez tej świadomości, starannego weryfikowania faktów i docenienia naszych osiągnięć grozi nam uleganie niesprawdzonym argumentom przeciwników integracji europejskiej i popełnienie nieodwracalnych błędów. Dla tych, którzy chcą poznać te fakty, przygotowany został raport "Nasza Europa. 15 lat Polski w Unii Europejskiej". Podjęto w nim ocenę 15 lat członkostwa Polski z perspektywy doświadczeń procesu integracji, z jego barierami i sukcesami, a także wyzwaniami przyszłości.
Raport jest wynikiem pracy zbiorowej licznych ekspertów z różnych dziedzin, od wielu lat analizujących wielowymiarowe efekty działania instytucji UE oraz współpracy z krajami członkowskimi na podstawie europejskich wartości i mechanizmów. Autorzy podsumowują korzyści członkostwa Polski w Unii Europejskiej na podstawie faktów, nie stroniąc jednakże od własnych ocen i refleksji.
This report is the result of the joint work of a number of experts from various fields who have been - for many years – analysing the multidimensional effects of EU institutions and cooperation with Member States pursuant to European values and mechanisms. The authors summarise the benefits of Poland’s membership in the EU based on facts; however, they do not hide their own views and reflections. They also demonstrate the barriers and challenges to further European integration.
This report was prepared by CASE, one of the oldest independent think tanks in Central and Eastern Europe, utilising its nearly 30 years of experience in providing objective analyses and recommendations with respect to socioeconomic topics. It is both an expression of concern about Poland’s future in the EU, as well as the authors’ contribution to the debate on further European integration.
Poland’s new Employee Capital Plans (PPK) scheme, which is mandatory for employers, started to be implemented in July 2019. The article looks at the systemic solutions applied in the programme from the perspective of the concept of the simultaneous reconstruction of the retirement pension system. The aim is to present arguments for and against the project from the point of view of various actors, and to assess the chances of success for the new system. The article offers a detailed study of legal solutions, an analysis of the literature on the subject, and reports of institutions that supervise pension funds. The results of this analysis point to the lack of cohesion between certain solutions of the 1999 pension reform and expose a lack of consistency in how the reform was carried out, which led to the eventual removal of the capital part of the pension system. The study shows that additional saving for old age is advisable in the country’s current demographic situation and necessary for both economic and social reasons. However, the systemic solutions offered by the government appear to be chiefly designated to serve short-term state interests and do not create sufficient incentives for pension plan participants to join the programme.
The document summarizes the evolution of the Belarusian public sector from a command economy to state capitalism. It discusses how the Belarusian economic model has changed over time, moving from a quasi-Soviet system based on state property and central planning, to a more flexible hybrid model where the public sector still dominates the economy. The paper analyzes the role and characteristics of the state sector in Belarus and how it has developed since independence. It considers various theoretical perspectives for understanding statist economies like Belarus, but concludes that a new multidisciplinary approach is needed to fully capture the dual nature of the Belarusian economic system.
Belarusian economy has been stagnating in 2011-2015 after 15 years of a high annual average growth rate. In 2015, after four years of stagnation, the Belarusian economy slid into a recession, its first since 1996, and experienced both cyclical and structural recessions. Since 2015, the Belarusian government and the National Bank of Belarus have been giving economic reforms a good chance thanks to gradual but consistent actions aimed at maintaining macroeconomic stability and economic liberalization. It seems that the economic authorities have sustained more transformation efforts during 2015-2018 than in the previous 24 years since 1991.
As the relative welfare level in Belarus is currently 64% compared to the Central and Eastern Europe (CEE) countries average, Belarus needs to build stronger fundaments of sustainable growth by continuing and accelerating the implementation of institutional transformation, primarily by fostering elimination of existing administrative mechanisms of inefficient resource allocation. Based on the experience of the CEE countries’ economic transformation, we highlight five lessons for the purpose of the economic reforms that Belarus still faces today: keeping macroeconomic stability, restructuring and improving the governance of state-owned enterprises, developing the financial market, increasing taxation efficiency, and deepening fiscal decentralization.
Inflation in advanced economies is low by historical standards but there is no threat of deflation. Slower economic growth is caused by supply-side constraints rather than low inflation. Below-the-target inflation does not damage the reputation of central banks. Thus, central banks should not try to bring inflation back to the targeted level of 2%. Rather, they should revise the inflation target downwards and publicly explain the rationale for such a move. Risks to the independence of central banks come from their additional mandates (beyond price stability) and populist politics.
Estonia has Europe’s most transparent tax system (while Poland is second-to-last, in 35th place), and is also known for its pioneering approach to taxation of legal persons’ income. Since 2000, payers of Estonian corporate tax don’t pay tax on their profits as long as they don’t realize them. In principle, this approach should make access to capital easier, spark investment by companies and contribute to faster economic growth. Are these and other positive effects really noticeable in Estonia? Have other countries followed in this country’s footsteps? Would deferment of income tax be possible and beneficial for Poland? How would this affect revenue from tax on corporate profits? Would investors come to see Poland as a tax haven? Does the Estonian system limit tax avoidance and evasion, or actually the opposite? Is such a system fair? Are intermediate solutions possible, which would combine the strengths or limit the weaknesses of the classical and Estonian models of profit tax? These questions are discussed in the mBank-CASE seminar Proceeding no. 163, written by Dmitri Jegorov, deputy general secretary of the Estonian Finance Ministry, who directs the country’s tax and customs policy, Dr. Anna Leszczyłowska of the Poznań University of Economics and Business and Aleksander Łożykowski of the Warsaw School of Economics.
The trade war between the U.S. and China began in March 2018. The American side raised import duties on aluminum and steel from China, which were later extended to other countries, including Canada, Mexico and the EU member states. This drew a negative reaction from those countries and bilateral negotiations with the U.S. In June 2018 America, referring to Section 301 of its 1974 Trade Act, raised tariffs to 25% on 818 groups of products imported from China, arguing that the tariff increase was a response to years of theft of American intellectual property and dishonest trade practices, which has caused the U.S. trade deficit.
Will this trade war mean the collapse of the multilateral trading system and a transition to bilateral relationships? What are the possibilities for increasing tariffs in light of World Trade Organization rules? Can the conflict be resolved using the WTO dispute-resolution mechanism? What are the consequences of the trade war for American consumers and producers, and for suppliers from other countries? How high will tariffs climb as a result of a global trade war? How far can trade volumes and GDP fall if the worst-case scenario comes to pass? Professor Jan J. Michałek and Dr. Przemysław Woźniak give answers to these questions in the mBank-CASE Seminar Proceeding No. 161.
This Report has been prepared for the European Commission, DG TAXUD under contract TAXUD/2017/DE/329, “Study and Reports on the VAT Gap in the EU-28 Member States” and serves as a follow-up to the six reports published between 2013 and 2018.
This Study contains new estimates of the Value Added Tax (VAT) Gap for 2017, as well as updated estimates for 2013-2016. As a novelty in this series of reports, so called “fast VAT Gap estimates” are also presented the year immediately preceding the analysis, namely for 2018. In addition, the study reports the results of the econometric analysis of VAT Gap determinants initiated and initially reported in the 2018 Report (Poniatowski et al., 2018). It also scrutinises the Policy Gap in 2017 as well as the contribution that reduced rates and exemptions made to the theoretical VAT revenue losses.
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CASE Network Studies and Analyses 345 - Current Account Imbalances in the Euro Area (draft version)
1. S t u d i a i A n a l i z y
S t u d i e s & A n a l y s e s
C e n t r um A n a l i z
S p o l e c z n o – E k o n omi c z n y c h
C e n t e r f o r S o c i a l
a n d E c o n omi c R e s e a r c h
3 4 5
Alan Ahearne, Birgit Schmitz, Jürgen von Hagen
Current Account Imbalances in the Euro Area
(draft version)
W a r s a w , M a r c h 2 0 0 7
3. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Contents
Abstract .......................................................................................................................... 5
1. Introduction................................................................................................................ 6
2. Stylized facts.............................................................................................................. 7
3. Net financial flows and EMU................................................................................... 15
3.1 Data ..................................................................................................................... 15
3.2 Trade balances and income per capita ............................................................ 19
4. Monetary Union and the Feldstein Horioka Puzzle............................................... 25
5. Estimating trade balance models........................................................................... 26
6. Conclusions ............................................................................................................. 43
References ................................................................................................................... 44
4. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Alan Ahearne (Ph.D), Vice Dean for Research at the Department of Economics at the J.E.
Cairnes Graduate School of Business and Public Policy at NUI Galway. His major research and
consulting interests are housing prices in Ireland and other industrial countries, global current
account imbalances and exchange rates, currency strategies for multinational corporations, and
the economic performance of the euro area.
alan.ahearne@bruegel.org
Birgit Schmitz (Ph.D), Assistant Professor at the Institute for International Economics,
University of Bonn. Her main research fields include Monetary Policy Transmission, Banking and
EU Enlargement.
birgit.schmitz@uni-bonn.de
Jürgen von Hagen (Ph.D), Professor of Economics, University of Bonn, Indiana University, and
CEPR. His interests include international and monetary macroeconomics and public finance.
vonhagen@uni-bonn.de
5. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Abstract
The dispersion in current account balances among countries in the euro area has
widened markedly over the past decade-and-a-half, and especially since 1999. We decompose
current account positions for euro area countries into intra-euro-area balances and extra-euro-area
balances and examine the determinants of these balances. Regarding intra-euro-area
balances, we present evidence that capital tends to flow from high-income euro area economies
to low-income euro area economies. These flows have increased since the creation of the single
currency in Europe.
We construct a novel data set regarding extra-euro-area balances. The data set contains,
for the euro area and the most important member economies, exports and imports to and from
the 10 respective most important trade partners outside the euro area. This allows us to study
the determinants of the extra-euro current account and its interaction with intra-euro area trade
balances. We estimate a model of the trade balance of the euro area and individual euro-area
countries with the rest of the world. We find that a real appreciation of the euro against the
currencies of its main trading partners appears to have a substantial effect on the euro area’s
net exports in the long run, though the immediate effect is small. Our estimates for individual
countries suggest that the adjustment to a real appreciation of the euro would not be equally
distributed across euro-area countries. In particular, Germany would bear the largest share of
the adjustment, while the other large euro-area economies would be relatively unaffected.
Finally, we find that the introduction of the euro seems to have changed the dynamics of trade
balance adjustment in three of the larger euro-area economies.
6. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
1. Introduction
The observation of rising and persistent global imbalances has been the focus of lively
debate among policymakers and academic economists in recent years. Most of that debate has
concentrated on the large U.S. current account deficit and its main counterpart, the large current
account surpluses of countries in Asia. Europe has not attracted much attention in this debate,
most likely because European countries and the European Union as a whole have a long
tradition of keeping their current accounts relatively close to balance (see Ahearne and von
Hagen, 2005). Nevertheless, current account developments in Europe deserve attention for
several reasons. For starters, current account imbalances within the EU and, in particular,
among the countries participating in European Monetary Union (EMU) have grown considerably
in recent years. A natural question to ask is whether these imbalances can be explained by
fundamental economic factors or whether they might point to a potential unsustainability of the
common currency.
In addition, as argued in Ahearne and von Hagen (2005), Europe, and the euro area in
particular, might be forced to run significant current account deficits in the future, if the United
States takes action to close its current account deficit or the U.S. dollar depreciates sharply and
the Asian countries insist on running surpluses and start accumulating euro reserves instead of
dollar reserves. The question here is: What are the consequences of a significant appreciation of
the euro for the euro area’s current account position?
This paper explores the determinants of the current account balances of the euro area
and individual member countries of the euro area. We are interested in both intra-euro-area and
extra-euro-area current account balances. Below, we look at the issue from two perspectives.
The first interprets current account balances as the counterpart of capital flows and asks to what
extent they can be explained by economic convergence among countries with different per-capita
incomes. The second perspective interprets current accounts in the traditional way of
exports and imports of goods and services and asks to what extent they can be explained by
movements in aggregate real incomes and real exchange rates.
We have divided the paper into 5 sections. After this brief introduction, we present some
stylised facts on current account balances in the euro area. In Section 3, we present evidence
7. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
that capital tends to flow from high-income euro area economies to low-income euro area
economies. These flows have increased since the creation of the single currency in Europe. In
Section 4, we turn our attention to extra-EMU trade and estimate a model of the trade balance of
the euro area and individual member countries of the euro area with the rest of the world. We
find that a real appreciation of the euro against the currencies of its main trading partners
appears to have a substantial effect on the euro area’s net exports in the long run, though the
immediate effect is small. Our estimates for individual countries suggest that the adjustment to a
real appreciation of the euro would not be equally distributed across euro-area countries. In
particular, Germany would bear the largest share of the adjustment, while the other large euro-area
economies would be relatively unaffected. Finally, we find that the introduction of the euro
seems to have changed the dynamics of trade balance adjustment in three of the larger euro-area
economies. We close with a few concluding remarks.
2. Stylized facts
This section presents some of the main stylised facts about individual EMU member
countries’ current account balances. Figure 1 shows the current account balances for the euro
area as a whole and for individual EU countries in selected years since 1985. As an aggregate,
the euro area tends to be financially largely selfcontained and contribute little to absorb current
account imbalances in other parts of the world. Current account balances were typically small
over this 20 year period, with 1995 being a noticeable exception. This is not withstanding the
fact that some EU countries have sizable current account imbalances. Germany, for example,
has recorded annual surpluses of around $100 billion in recent years. Germany’s surplus is
estimated to have reached 4¼ percent of GDP in 2006. This has brought Germany back to its
traditional position of surplus, which we observe in 1985. Finland, Sweden, and the Netherlands
have run even larger surpluses relative to GDP in the past six years. In contrast, Portugal’s
current account deficit was nearly 10 percent of GDP in 2006, while deficits in Greece and Spain
exceeded 8 percent of GDP. All three countries have had sizeable deficits since the start of
EMU.1
1 See Blanchard and Giavazzi (2002) for a discussion of Greece and Portugal in this regard.
8. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 1. European current account balances (% of GDP)
Figure 2. European current account balances (% of GDP)
Source: Estimates from IMF WEO September 2006
9. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 2 shows the evolution of current account balances under EMU. There is a group
of countries consisting of Luxembourg, Finland, the Netherlands, and Germany, that consistently
ran surpluses during the past five years. Germany registered small current account deficits
averaging about 1 percent of GDP during most of the 1990s. The German balance swung into
surplus in 2002 and the surplus has widened steadily over recent years as German exports have
outpaced imports. Recent years have also seen a marked increase in the current account
surplus in the Netherlands, while Finland’s surplus has returned to roughly its level at the
beginning of EMU, after widening to nearly 10 percent in 2001. At the other end of the spectrum,
Greece, Portugal, and Spain have consistently run current account deficits in the past five years,
and their deficits have widened significantly under EMU and during the period in the run-up to
EMU. All three countries had current account positions close to balance around the mid-1990s.
Recent years have seen an especially sharp decline in Spain’s current account balance from
roughly 3½ percent of GDP in 2003 to an estimated 8¼ percent of GDP in 2006. Current
account deficits of the magnitudes seen in Greece, Portugal, and Spain at present are
unprecedented among euro area countries, with the exception of Ireland in the mid-1980s and
Portugal in the 1970s (European Commission, 2006).
Current account deficits of more than 8 percent of GDP are also large compared with
other non-euro-area advanced economies. Continual current account deficits accumulate to the
net international investment position. Net external liabilities relative to GDP have soared to
nearly 80 percent in Greece, 60 percent in Portugal, and 40 percent in Spain.
One interpretation of the evolution of current account balances under EMU is that the increased
dispersion of current account positions has been driven by trade flows that reflect shifts in
relative competitiveness within the euro area. (See, for example, Blanchard 2006, European
Commission 2006, and Munchau 2006).
10. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 2a. Current account balances under EMU (% of GDP)
Figure 2b. Current account balances under EMU (% of GDP)
11. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 2c. Current account balances under EMU (% of GDP)
Source: IMF. Estimates for 2006 from IMF WEO September 2006.
On this account, aggregate demand was too strong in some countries and too weak in
others, resulting in persistent differences in inflation rates across countries. In fact, the size and
persistence of inflation differentials at the national level is one of the most widely recognized and
documented facts relating to the start of EMU. As a result of persistent differences in inflation
across countries, euro area economies have experienced very sizeable swings in the real
exchange rates vis-à-vis their peers, as shown in Figure 3. In turn, the changes in
competitiveness associated with these movements in real exchange rates may have played a
role in bringing about the large swings in current account balances. The relationship between
real exchange rate developments and current account balances portrayed in Figure 4 appears to
confirm that countries that have gained (lost) competitiveness relative to other euro-area
countries during EMU are now running large current account surpluses (deficits).
In particular, Blanchard (2006) ascribes Portugal’s economic boom in the late 1990s to the sharp
drop in interest rates and heightened expectations for faster convergence that resulted from
participation in EMU. Rapid economic growth and a decline in unemployment lead to an
increase in wage growth to a rate substantially above the growth in labour productivity. As a
result, competitiveness deteriorated sharply, export growth weakened, and Portugal’s trade and
current account deficits widened markedly. Ahearne and Pisani-Ferry (2006) document that over
the period 1999-2005, cumulative growth in Portugal’s gross exports was as much as 10
12. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
percentage points below the euro area average. Greece, Italy, and Spain also experienced
relatively sluggish growth in gross exports over this period.
Figure 3a. Real exchange rates
Figure 3b. Real exchange rates
13. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 3c. Real exchange rates
Source: own calculations based on Eurostat data.
Figure 4. Real exchange rate and current account balances
Source: Eurostat and IMF. Estimates for 2006 current account balances are from IMF WEO, September 2006.
14. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Some commentators have linked the strong performance of German exports over recent
years to gains in competitiveness associated with a rate of inflation that has been persistently
below the euro area average (see Ahearne and Pisani-Ferry, 2006; Münchau 2006). According
to this view, wage restraint, facilitated by a decline in unionization in Germany’s labour market,
has kept growth in unit labour costs well below the euro area average, boosting the
competitiveness of German exporters. Revealingly, two-thirds of the 1.2 percent annual average
growth in German GDP over the period 1999-2005 came from net exports, with only one-third
from growth in domestic demand (Ahearne and Pisani-Ferry, 2006).
The policy implication from this perspective is that, in order to achieve internal balance,
deficit countries in the euro area need fiscal contractions to slow down aggregate demand and
that the surplus countries ought to boost aggregate demand. One problem with this prescription,
however, is that Germany and the Netherlands had troubles meeting their obligations under the
Stability and Growth Pact until recently and have little room for manoeuvre with regard to fiscal
policy. Most of the adjustment would thus have to come from the deficit countries.
An important question is how the large current account deficits in Greece, Portugal, and
Spain are being financed. The European Commission (2006) documents that a large part of the
net financial inflows into these countries during EMU have taken the form of bank loans. For
Greece, net portfolio inflows have also been important. Outflows of foreign direct investment
have generally exceeded inflows in each of the three countries. In Germany, lending abroad by
German banks exceeded foreign borrowing by German banks to the tune of about 2½ percent of
GDP annually on average over the period 1999-2005.
In contrast, in the period 1992-1998, German banks were significant net borrowers from
the rest of the world. One hypothesis is that by eliminating exchange rate risk, the creation of the
single currency in Europe has boosted financial flows from high-income to low-income countries
in the euro area. Financial flows from high-income countries in the euro area to low-income
countries outside of the euro area have not increased. Of course, EMU has coincided with other
efforts to promote increased financial integration in Europe. In the next section, we examine in
more detail the pattern of net financial flows between European countries and between
European and non-European countries.
15. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
3. Net financial flows and EMU
The alternative interpretation of current account imbalances is that they reflect capital
flows. Neoclassical growth theory predicts that capital should flow from rich countries to poor
countries. Poor countries have lower levels of capital per worker— in part, that explains why they
are poor. In poor countries, the scarcity of capital relative to labour should mean that the returns
to capital are high. In response, savers in rich countries should look at poor countries as
profitable places in which to invest.2
In this section, we present some simple econometric evidence on the determinants of
capital flows between countries in the EU-15 and between EU-15 countries and non-EU-15
countries. Ideally, we would use individual country data on intra-EU-15 and extra-EU-15 current
account positions to measure financial flows, but these data are not readily available. As a proxy
for current account balances, therefore, we use intra-EU-15 and extra-EU-15 trade balances.3
Our main aim is to examine whether capital tends to flow from rich to poor EU-15 countries, and
whether the creation of the single currency in Europe has affected these flows.
3.1 Data
We use annual data on exports and imports of goods over the period 1981- 2005. Our
sample covers the EU-15 countries, excluding Luxembourg. We have individual country data on
both intra-EU-15 and extra-EU-15 exports and imports of goods. Exports and imports of services
are not included because of a lack of reliable data. We consider intra-EU-15 trade balances
(calculated as a country’s exports to other EU-15 countries less imports from other EU-15
countries), extra-EU-15 trade balances (calculated as a country’s exports to non-EU-15
countries less imports from non-EU-15 countries), and total trade balances (calculated as the
sum of intra-EU-15 and extra-EU-15 trade balances). We also focus on the subset of EU-15
2 In reality, surprisingly little capital flows from rich countries to poor countries (see Lucas,
1990). Several candidate explanations have been put forward, including differences in human
capital between rich and poor countries as well as failures in international capital markets that
might account for the lack of flows. However, none of these candidates can come near to
explaining quantitatively the observed shortage of capital flows relative to what economic
theory would predict.
3 Based on the AMECO data used below, the correlation between total trade balances and current
accounts is above 0.91 for all countries except the UK (0.73) and Ireland (-0.16).
16. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
countries that are members of the euro area. All data is taken from the European Commission’s
AMECO data bank.
Figure 5 plots over time the dispersion across countries of each of the five different types
of trade balances, defined as the unweighted cross-section standard deviation. The dispersion in
trade balances trended upwards during the 1990s and then accelerated somewhat after 1999.
The observation of widening differences among the current account balances of EU member
states is also found in Blanchard (2006), who looks at the total current account of each country
with the rest of the world and shows that the dispersion also increases among OECD countries.
Figure 5 shows that the dispersion of intra-EU trade balances is consistently larger than the
dispersion of extra-EU trade balances, and that the former has risen faster than the latter since
the mid-1980s. Separating euro and non-euro countries from the EU-15 group makes no
significant difference.
Figure 6 shows the behaviour of the (unweighted) average of trade balances over the
past 25 years. It indicates that the average EU-15 country had a trade surplus against its EU
partners since the mid-1990s, and a slight deficit against non-EU countries since the start of
EMU. We also counted the number of years in which a country’s trade balance against its EU
partners had the same or the opposite sign from its trade balance against the rest of the world.
Greece had the same sign on both balances in all 25 years, Portugal in 23 years and Spain in
21 years. In contrast, Germany and the Netherlands had opposite signs on the two balances in
all 25 years. Thus, countries running deficits against their EU partners consistently in past years
tended to borrow from those and from the rest of the world. In contrast, Germany and the
Netherlands tended to borrow from the rest of the world and lend to other EU countries, thus
positioning themselves as financial intermediaries in Europe.
17. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 5. Dispersion of Trade Balances (Standard deviation, % of GDP)
Figure 6. Average Trade Balances (% of GDP)
18. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Table 1 shows the correlation coefficients between the intra and the extra EU trade
balances for our sample countries. For Germany, Spain, the Netherlands, and Portugal, the
correlation is significantly negative, i.e., an increasing trade deficit w.r.t. other EU countries tends
to be compensated by a shrinking deficit w.r.t. the rest of the world. For the other countries, the
correlation is positive. Table 2 reports the results of bi-variate causality tests between intra and
extra EU trade balances. Generally,dynamic correlations between the two are small and
insignificant. In Spain and Portugal, we find causality running from the extra to the intra EU trade
balance with a negative effect of the former on the latter. In Finland, there is causality in the
same direction, but with a positive effect. In Spain, Austria and the UK, we find causality from the
intra to the extra EU balance, with a positive effect in the case of Spain and the UK, and a
negative effect in the case of Austria.
Table 1. Correlation between Intra and Extra-EU Trade Balances
Table 2. Causality Tests Between Intra and Extra-EU Trade Balances
Note: Table entries are the p-values of an F-test of the significance of two lags of the potentially causal variable in a
regression where two lags of the caused variable are used. All regressions are in first differences.
19. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
3.2 Trade balances and income per capita
We run some simple OLS regressions to examine the determinants of trade balances in
individual European countries. We are particularly interested in any possible relationship
between trade balances (and therefore financial flows) and income per capita. The dependent
variable in our regressions is the ratio of the trade balance to GDP. We consider three variations
of the dependent variable, corresponding to the different measures of the trade balance for EU-
15 countries discussed above: total trade balance to GDP, intra-EU-15 trade balance to GDP,
and extra-EU-15 trade balance to GDP.
The main explanatory variable is real per-capita GDP. We also include this variable interacted
with a dummy variable for the start of EMU in 1999, and dummies for the euro and the non-eura
area countries from 1999 on. We also included a dummy variable for German unification, but this
turned out not to be statistically significant.
Our results are presented in Table 3A-C. We report four specifications for each
dependent variable. The first uses only the dummies and GDP-per-capita as explanatory
variables. The second adds the general government balance as a ratio of GDP and the real
price of oil in US dollars. The former is motivated by the effect public sector deficits have on the
current account in conventional macro models. The latter is motivated by the fact that EU
countries except the UK are dependent on oil imports. The third specification adds time
dummies to the model and uses a GLS estimator accounting for panel heteroskedasticity and
first-order autocorrelation of the residuals. The final specification adds a number of additional
explanatory variables as a robustness check, namely real GDP-per-capita in the EU and a
measure of the real effective exchange rate.
Consider Table 3A, column A. We find that trade surpluses within the EU are a positive
function of per-capita income in the EU-15 and that the relationship is strongly statistically
significant. Generally, countries with larger per-capita GDPs have larger intra EU trade balances.
Before the start of EMU, the effect of a rising GDP per capita on a country’s intra-EU trade
balance is 0.59. This positive coefficient becomes notably and significantly stronger for the euro-area
countries after the beginning of EMU, and significantly weaker for non-EMU countries.
Thus, effect we observe is not merely a general effect for all EU countries. Instead, the
estimates indicate that EMU has changed the direction of capital flows within the euro area
significantly.
20. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
The remaining specifications show that this result is robust. Fiscal balances have a
significantly positive effect on the intra-EU trade balance. In the simplest specification, a rise in
the fiscal balance by one percent of GDP raises the intra-EU trade balance by 0.25 percent of
GDP. Including time dummies and using a GSL estimator reduces that effect to 0.11 percent of
GDP. Since the government balance might be considered endogenous relative to the trade
balance, e.g., because governments might pursue a current account target for fiscal policy, we
also estimated models using an instrument for the government balance based on two lags of the
government balance and two lags of the total trade balance as well as using the lagged balance
as an explanatory variable. In both cases, the government balance retained a positive
coefficient, but its marginal significance level dropped below 10 percent. 4
The real price of oil has a negative impact on the intra-EU trade balance, which is significant
only in the GLS estimation in column C. We find that average EU GDP per capita has a negative
effect on the trade balance, which is consistent with what one would expect from theory (e.g.,
Chinn and Prasad, 2003). However, the effect is not statistically significant. A country’s intra-EU
real effective real exchange rate has a significant, negative effect on the trade balance,
consistent with standard open-economy macro models. Adding these controls does not change
the main result regarding the effects of per-capita GDP and the EMU and non-EMU effects.
Next, consider Table 3B, column A. Again, we find that trade surpluses are significantly
and positively linked to real GDP per capital. However, this relationship does not change with
the introduction of the euro, neither for euro-area countries nor for countries outside the euro
area. This reinforces the suggestion that the introduction of the euro has changed net trade
flows within the euro area alone.
Interestingly, the fiscal balance has a positive coefficient in these regressions, but it is not
statistically significant. This suggests that the effects of changes in fiscal balances fall primarily
on intra-EU trade. The real oil price has a significantly negative effect on the trade balance. This
effect, however, is only significant in the smaller specifications of columns B and C.
Finally, Table 3C confirms the same results for total trade balances. The effect of per-capita
GDP on total trade balances increases for the euro-area countries with the beginning of
EMU, while it decreases for the non-euro area countries. The effect of fiscal balances on total
trade balances is positive and significant. A rise in the fiscal balance by one percent of GDP
raises the trade balance by about 0.2 percent of GDP. This indicates that only about one percent
4 We also estimated models using instruments for the government budget balance for the extra-EU
trade balance and the total trade balance. The results were similar and are not reported below.
21. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
of Portugal’s trade deficit of 12.6 percent in 2005 can be explained by its general government
deficit of 5.6 percent. Meanwhile, Spain’s trade deficit (8.6 percent of GDP in 2005) would have
been even larger had the country not had a government surplus of one percent of GDP. 5
These results suggest that EMU has increased capital market integration in Europe with
the result that capital flows are now more in line with what neoclassical growth theory predicts.
As capital flows from high-per capita GDP to low-per capita GDP countries, they can be
expected to promote economic convergence among the euro-area countries. This means that
the allocation of capital is becoming more efficient in Europe, and that the observed current
account imbalances indicate that the monetary union works well. By implication, a fiscal
expansion in the surplus countries would tend to absorb more of their domestic savings and
slow down capital flows to poorer countries, thus rendering EMU less efficient.
Given the simplicity of our estimated equations, these results are suggestive rather than
definitive. Nonetheless, our reading of the results is that monetary union seems to have made a
difference in that high-income countries have become lenders to low-income countries within
EMU much more than on a global scale. This shows that monetary union has greatly increased
capital market integration among the participating countries. More efficient capital allocation
within the region is a major benefit from monetary union. But note that monetary integration, not
unlike trade integration, also seems to have had a negative effect on capital market integration
between euro-area countries and non-euro area countries. This effect, which is in analogy to the
well-known trade diversion effect of trade integration, implies a possible worsening of the
allocation of capital between the euro area and the rest of the world.
5 De Santis and Lührmann (2006) and Chinn and Prasad (2003) find that relative per-capita income has
a positive effect on the current account balance in a large panel of countries running frm 1970 to 2003.
They also employ squared relative income as a regressor. Following their papers, we used squared per
capita income as an additional regressor in the models for the intra, extra, and total balances but did not
find a significant effect.
22. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Table 3A. Dependent Variable Intra EU Trade Balance
Note: GLS estimator accounts for heteroskedasticity between countries and countryspecific autocorrelation of
residuals. Standard errors in parentheses. *, **, *** denote statistical significance of the 10, 5, and 1 percent level
respectively.
23. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Table 3B. Dependent Variable Extra-EU Trade Balance
Note: GLS estimator accounts for heteroskedasticity between countries and countryspecific autocorrelation of
residuals. Standard errors in parentheses. *, **, *** denote statistical significance of the 10, 5, and 1 percent level
respectively.
24. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Table 3C. Dependent Variable Total Trade Balance
Note: GLS estimator accounts for heteroskedasticity between countries and countryspecific autocorrelation of
residuals. Standard errors in parentheses. *, **, *** denote statistical significance of the 10, 5, and 1 percent level
respectively.
25. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
4. Monetary Union and the Feldstein Horioka Puzzle
In a seminal contribution to open-economy macro economics, Feldstein and Horioka
(1980) showed that, at the time, international capital market integration was much weaker than
generally perceived. They did this based on a simple reasoning. With complete international
capital market integration, a country’s rate of investment should be uncorrelated with its rate of
savings. Any excess of investment over savings would simply be absorbed by the current
account balance. This suggests that the regression coefficient of the investment on the savings
ratio, which is called the savings retention coefficient, should not be statistically different from
zero. However, Feldstein and Horioka showed that, in an international panel, that coefficient was
much closer to one than to zero. Subsequent literature has shown that the savings retention
coefficient has declined in international panels since the 1980s.6 This is in line with the general
perception that the degree of international capital markets integration has increased since then.
Blanchard and Giavazzi (2002) revisit this issue in the context of EMU. They use annual
data for investment and savings ratios of OECD, EU, and euro-area countries from 1975 to 2000
and estimate savings retention coefficients. Blanchard and Giavazzi show that savings retention
coefficients generally from levels of 0.5 to values close to zero for all three groups of countries.
Showing that savings retention coefficients declined would support our interpretation of
the current account imbalances in the euro area, since it is another aspect of looking at capital
market integration. With this in mind, we consider Feldstein Horioka regressions for our 14
countries and the period from 1981 to 2005. The dependent variable is the gross investment
rate, which includes public sector investment. The explanatory variable is the gross savings rate,
which includes public sector savings. All data are from the AMECO data base.
6 See e.g. Obstfeld and Taylor (2004) and Hericourt and Maurel (2005) for a recent, comprehensive
survey.
26. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Table 4. Feldstein Horioka Regressions for EU Countries, 1981-2005
Dependent Variable: Gross Investment Rate
Source: Own estimations
Table 4 reports the results. The coefficient on the gross savings rate is 0.43 and
statistically significant. This is lower than what Feldstein and Horioka found, but well in line with
Blanchard and Giavazzi (2002). Interacting the gross savings rate with an EMU dummy for the
euro-area countries yields a negative coefficient of -0.63. The total effect post-1999 of -0.23 is
not statistically different from zero. Thus, domestic investment has been completely decoupled
from domestic savings in the euro-area countries. Interacting the gross savings rate with our
non-EMU dummy yields a negative coefficient which is much smaller and not statistically
different from zero. Thus, table 4 supports our results that EMU has increased capital market
integration within the region, but not for outsiders.
5. Estimating trade balance models
The emphasis in the previous section was on capital flows within the euro area. In this
section, we present empirical estimates of a model explaining the trade balance of the euro area
and individual member countries of the euro area with the rest of the world. We use quarterly
data for the period from 1980:Q1 to 2005:Q2. Exports and imports for the euro area are
27. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
computed for the ten most important trade partners outside the euro area. This covers
approximately 60 percent of the total trade with the rest of the world. For the member countries,
we use total exports (imports) and subtract exports (imports) to other euro-area countries. We
use data from the IMF’s Direction of Trade statistics, and focus on exports and imports of goods
since, as mentioned earlier, data for trade in services are not readily available, nor are current
account data with regard to non-euro area countries. Exports and imports are measured in U.S.
dollars for all countries. We normalize the trade balance by dividing by domestic GDP in U.S.
dollars.
Our baseline model seeks to explain the trade balance using domestic and foreign real
GDP and the effective real exchange rate. For each country and the euro area, we calculate
“foreign” GDP by taking the nominal GDP of the ten most important trade partners outside the
euro area converted into US dollars and deflating it by the US CPI. Our regressions use the ratio
of domestic real GDP to foreign real GDP as an explanatory variable. Note that domestic real
GDP is computed in terms of the relevant country’s or the euro area’s own currency, while
“foreign” real GDP is calculated in terms of real US dollars. Converting the former into real
dollars - or the latter into real euros – would result in a series which is entirely dominated by real
exchange rate movements such that the information about real GDP is wiped out. Both real GDP
series are computed as indexes with the first quarter of 1999 as base period and are converted
into logs.
Figures 7-13 show the trade balances relative to GDP together with the real exchange
rates and the relative GDP variables. For the euro area, Figure 7 gives three measures of the
trade account. The line CA gives the trade balance of the aggregate euro area according to the
IMF’s Direction of Trade Statistics (December 2006). “Extra CA” gives the sum of all of euro
area-countries net exports to the rest of the world less the same countries’ net exports to other
euro-area countries. The figure shows that there are some data discrepancies that are due to
the statistical separation of Belgium and Luxembourg in the late 1990s. The figure also shows
the euro-area’s net exports to its ten most important trade partners. This line tracks the total
trade balance very closely except for a period in the mid-1990s.
Figure 7 shows that for the euro area as a whole the trade balance has remained within a
band of plus/minus 2 percent of GDP in all but two years in the past 25 years, and the two
exceptions are in the early part of the sample. In the past 10 years, it has hovered between zero
and 2 percent of GDP. There are larger discrepancies across the four largest euro-area
economies, Germany, France, Italy, and Spain, as shown in Figure 9. Individual trade balances
range between plus and minus five percent of individual country GDP. While Spain consistently
28. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
experienced trade deficits throughout the period, the other three large economies consistently
had trade surpluses, and Germany had the largest of these.
Figure 7.
29. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 8.
30. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 9.
Figure 8 shows the relative GDP of the euro area against its ten largest trade partners (in
logs, as explained above). The series oscillates between -0.05 and 0.1 with a slight upward
trend since the mid-1980s. The figure also shows the real exchange rate of the euro area
against its ten largest trade partners. Following a large real depreciation of the euro in the first
half of the 1980s, we observe a real appreciation in the subsequent decade, and especially in
the years 1992-1995. This was followed by a rapid depreciation which ended in an appreciation
after 2001 that brought the real value of the euro back to its long-run average. Figures 10-13
show that individual country experiences exhibit similar patterns, although with swings of larger
amplitudes. On aggregate, therefore, the euro area is less volatile against outside countries than
its individual member countries. A notable exception to the general impression is the relative
GDP series for Spain, which exhibits a continuous upward trend throughout the period.
31. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 10.
32. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 11.
33. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 12.
34. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 13.
Table 5 presents estimates of a simple model of dynamic adjustment of the trade
balance. The dependent variable is the trade balance of the euro area and its four largest
constituent economies with regard to non-euro area economies. The explanatory variables are a
lagged dependent variable, the growth rate of domestic real GDP less the growth rate of the real
GDP of the ten largest (non-euro area) trade partners, and the effective real exchange rate
against the ten largest non-euro area trade partners. The effective real exchange rate is
measured in logs. The estimates are based on quarterly data. Preliminary estimates using more
elaborate lag structures did not yield qualitatively different results.
The estimates show that trade balances are very persistent. The first-order auto-regression
coefficients range between 0.7 and 0.8 for the individual countries and the coefficient
for the euro-area aggregate is 0.89. For the euro area, the coefficients on the relative real-income
variable and the real exchange rate are both statistically significant and correctly signed.
35. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
An increase in the domestic real growth rate by one percent above the foreign growth rate leads
to a fall in the trade balance by 0.024 percent of GDP on impact, and 0.22 percent in the long
run. A rise in the real exchange rate by 10 percent lowers the trade balance by 0.084 percent on
impact, and by 0.76 percent in the long run. Thus, a real appreciation of the euro against its
main trade partners seems to have a substantial effect on net exports in the long run, although
the immediate effect is small.
36. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Table 5. Estimated trade balance models
Turning to the individual countries, the performance of the model estimates is
considerably weaker. Germany is the only euro-area country whose trade balance with respect
to non-euro area countries responds significantly to changes in both the relative real GDP
growth rate and the real exchange rate. For Germany, a rise in the relative growth rate by one
37. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
percent leads to a fall in the trade balance by 0.055 percent on impact and 0.25 percent in the
long run. A real appreciation by 10 percent against the ten most important non-euro-area
countries leads to a fall in the trade balance by 0.2 percent of GDP on impact and 0.9 percent in
the long run. While the other countries show similar responses to changes in the relative GDP
growth rate, the responses of the Italian and Spanish trade balances to changes in the real
exchange rate are much weaker and not statistically significant. For France, we use the real
exchange rate and its first lag in the model. While the current real exchange rate has a positive
coefficient, the lagged real exchange rate has a negative coefficient and the total effect has the
expected negative sign. These estimates indicate that the adjustment to a real appreciation of
the euro against third countries would not be equally distributed across euro-area countries.
Germany would bear the largest part of the adjustment, while the other large economies would
seem relatively unaffected.
Next, we augment these models by a dummy variable which is zero until the fourth quarter of
1998 and one from the first quarter of 1999 onwards. This dummy allows us to test for and
estimate the size of structural breaks in the model coefficients at the start of EMU. We interact
the dummy with all explanatory variables in the model. For the euro-area aggregate and for
Germany, all terms with this dummy are statistically insignificant. We do not report them below.
For France, Italy, and Spain, in contrast, we find evidence for structural breaks around the start
of EMU. Table 6 shows the results.
For France and Italy, we find that the persistence of the trade balance is significantly
weaker after the start of EMU. The combined first-order autoregressive coefficient is 0.28 for
France and 0.09 for Italy after the start of EMU. For Spain, the persistence of the trade balance
remains unchanged, but we find that the responsiveness of the trade balance to changes in the
relative real growth rate vanishes after 1999. In contrast, the Spanish trade balance becomes
responsive to changes in the real exchange rate, although the effect remains small. In sum, the
introduction of the euro seems to have changed the dynamics of trade balance adjustment in
three of the larger euro-area economies.
38. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Table 6. Trade balance models and EMU
39. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
The persistence of the trade balances reported in our results is closely in line with VAR
results for Germany, France, and Italy by Lee and Chinn (2006). These authors also find a very
weak and statistically insignificant response of the French and Italian current accounts to the
real exchange rate, while the German current account responds negatively and significantly to
changes in the German real exchange rate.7
One weakness of the data used so far is that the trade weights employed to calculate the real
effective exchange rates and the real GDP of the ten largest trade partners are based on trade
data in 2005. The group of the 10 largest trade partners therefore includes countries that did not
exist as sovereign countries or did not participate in world trade as market economies in the
1980s. Furthermore, the opening of Central and Eastern Europe to international trade and the
rise of China as a trading nation have changed the trade weights significantly over the past 15
years.
To avoid potential biases resulting from these changes, we calculate the shares of the
euro area with non-euro area countries for each year since 1981 and recomputed the real GDP
of the 10 largest trade partners and the effective real exchange rate on that basis. Figures 14
and 15 show the difference these recalculations make for the explanatory variables of our
model. Figure 14 indicates that the new relative real GDP series lies above the original one for
all years during the 1980s. This suggests that the trade weights from 2005 give too much weight
to countries with relatively low GDP in the 1980s. The two series converge in the mid-1990s,
suggesting that there are no large changes in the trade structure of the euro area thereafter.
Figure 15 shows that the new effective real exchange rate series lies below the original one
during the 1980s, suggesting that the 2005 trade weights give too much weight to countries with
relatively weak currencies in the 1980s. The series exhibits a noticeable jump in 1990, the year
when China first appears among the top 10 trade partners of the euro area, while other countries
like the former Soviet Union disappear from that group.
7 Arghyrou and Chortareas (2006) report lower persistence of the current accounts of EU countries and
similar effects of the real exchange rate. However, these authors do not distinguish between intra and
extra EMU trade and do not account for the effects of income growth.
40. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 14.
41. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Figure 15.
Table 7 reports the results of estimating our trade balance model with the new data
series. The upper part of the table uses the full data set again. It shows that the persistence of
the trade balance remains very large, while the coefficient on the relative real GDP growth rates
has is somewhat smaller and the coefficient on the real exchange rate is considerably smaller in
numerical value than in Table 5. Nevertheless, the long-run effects of changes in relative real
GDP growth and the real exchange rate are similar to those estimated in Table 5.
42. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
Table 7: Trade balance models with dynamic trade shares
The lower part of Table 7 uses data only starting in 1991. We do this in view of the break
in the real exchange rate series in 1990. Here, we note a considerable decline in the persistence
of the trade account. At the same time, the coefficient on the relative real GDP growth rate more
than doubles, and the coefficient on the effective real exchange rate is twice the coefficient from
the upper part. Compared to the estimates using fixed trade weights, the short-run reaction of
the trade balance to changes in relative real GDP growth is much stronger, and the short-run
reaction to changes in the effective real exchange rate is moderately stronger. Nevertheless, the
long-run effects of changes in relative real GDP growth remain unchanged, while the long-run
effect of the effective real exchange rate is smaller than those based on the estimates with fixed
trade weights. A permanent appreciation of the real exchange rate of the euro by 10 percent
lowers the trade account by 0.55 percent of euro-area GDP in the long run.
43. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
6. Conclusions
We have documented a growing dispersion in current account balances among countries
in the euro area since the early 1990s. The differences in current account positions widened
significantly following the creation of EMU. We have shown, first, that EMU has changed the
pattern of capital flows within Europe. Specifically, it has increased the tendency of capital flows
to go from relatively rich to relatively poor countries within the euro area. This suggests that the
observed current account imbalances are sign of the proper functioning of the euro area rather
than a sign of improper macro economic management.
Furthermore, we have presented some preliminary estimates of current account
adjustment of the euro area and its constituent economies. Our estimates indicate that the long-run
effect of a real appreciation of the euro against the currencies of its main trade partners is
sizeable. Thus, in a scenario in which the dollar devalues against Asian currencies, the US
current account closes, but Asian countries stubbornly continue to run current account
surpluses, the euro area would experience a large deterioration of its trade balance.
Furthermore, this deterioration would be distributed unevenly across its member economies, at
least in the short run. Such a development could indeed pose a serious challenge to the
sustainability of the common currency. More empirical work, currently under way, is needed to
obtain more precise estimates of the outcomes of such a scenario.
44. Studies & Analyses CASE No. 345 – Current Account Imbalances in the Euro Area
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