Rebalancing the Euro area: The costs of internal devaluation

Engelbert Stockhammer and Dimitris Sotiropoulos

No PKWP1206, Working Papers from Post Keynesian Economics Society (PKES)

Abstract: This paper investigates the economic costs of Euro area rebalancing. Based on an old Keynesian model we estimate a current account equation, a wage-Phillips curve and an Okun’s Law equation. All estimations are carried out for a panel of eleven Euro area members (excluding Luxembourg). From the estimation results we calculate the output costs of reducing current account deficits. Greece, Ireland, Italy, Portugal and Spain (GIIPS) had, on average, current account deficits of 8.4% of GDP in 2007. To eliminate these current account deficits, it would necessitate a reduction of GPD by some 47%. These are staggering amounts and, indeed we think that such a reduction of GDP should not be imposed in the GIIPS group. Moreover, we doubt whether it would be politically feasible. In principle there are two ways that trade imbalances could be resolved: deflationary adjustment in the deficit countries or inflationary adjustment in the surplus countries. Presently, the burden of adjustment is exclusively on the deficit countries. Our results indicate that the economic costs of this adjustment to those countries are equivalent to the output loss of the Great Depression. An adjustment of the surplus countries would increase growth and it would come with higher inflation, but it would allow rebalancing without a Great Depression in parts of Europe.

Keywords: Rebalancing; Euro area; current account; Phillips curve; Okun’s law (search for similar items in EconPapers)
JEL-codes: E12 E60 F40 (search for similar items in EconPapers)
Pages: 30
Date: 2012-07
New Economics Papers: this item is included in nep-eec, nep-mac and nep-pke
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Related works:
Journal Article: Rebalancing the Euro Area: The Costs of Internal Devaluation (2014)
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