Current Account Imbalances in the Euro Area: Competitiveness or Financial Cycle?

51 Pages Posted: 23 Oct 2014

See all articles by Mariarosaria Comunale

Mariarosaria Comunale

Bank of Lithuania - Economics Department

Jeroen Hessel

De Nederlandsche Bank

Date Written: October 13, 2014

Abstract

The current account imbalances that are at the heart of the European sovereign debt crisis are often attributed to differences in price competitiveness. However, recent research suggests that domestic demand booms related to the financial cycle may have been more important. As this would have very different policy implications, this paper aims to investigate the relative role of price competitiveness and domestic demand as drivers of the current account imbalances in the euro area. We estimate panel error-correction models for exports, imports and the trade balance. We specifically look at fluctuations in domestic demand at the frequency of the financial cycle. We conclude that although differences in price competitiveness have an influence, differences in domestic demand are more important than is often realized. Fluctuations at the frequency of the financial cycle are more suitable to explain the trade balance than fluctuations at the frequency of the normal business cycle. Our results call for more emphasis on credit growth and macro prudential policy, in addition to the current attention for competitiveness and structural reforms.

Keywords: Current account deficits, Economic and Monetary Union, competitiveness, domestic boom, financial cycle

JEL Classification: E32, F32, F41, F44

Suggested Citation

Comunale, Mariarosaria and Hessel, Jeroen, Current Account Imbalances in the Euro Area: Competitiveness or Financial Cycle? (October 13, 2014). De Nederlandsche Bank Working Paper No. 443, Available at SSRN: https://ssrn.com/abstract=2509303 or http://dx.doi.org/10.2139/ssrn.2509303

Mariarosaria Comunale (Contact Author)

Bank of Lithuania - Economics Department ( email )

Totoriu 4
Vilnius, LT-01121
Lithuania

Jeroen Hessel

De Nederlandsche Bank ( email )

PO Box 98
1000 AB Amsterdam
Amsterdam, 1000 AB
Netherlands

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