The importance of trade and capital imbalances in the European debt crisis

Andrew Hughes Hallett and Juan Carlos Martinez Oliva

Journal of Policy Modeling, 2015, vol. 37, issue 2, 229-252

Abstract: The European crisis has highlighted the role of intra-European payments imbalances for the survival of the EMU. Payment imbalances between the North and the South have contributed to the accumulation of large stock of foreign debt, while flows of foreign capital ceased to finance productive investments which might have contributed to debt repayments—preferring instead to finance consumption and a housing bubble. The dynamic interplay between current account imbalances and the accumulation of debt reveals that, once the system is driven into disequilibrium by a real exchange rate misalignment, the longer a payments imbalance persists the harder the eventual adjustment will be. Capital reversals, by shifting portfolio balances, lead the system toward instability, sovereign default, and the collapse of the exchange rate regime. Replacing private with public creditors may temporarily help us to stay away from the point where the system breaks down. But this is only a temporary expedient because the underlying imbalances need continued and escalating financing until equilibrium is restored by other means. One permanent solution is the ECB's official monetary transactions program, if the potential expansions to the central bank's balance sheet can be tolerated.

Keywords: External debt; Trade space; Real exchange rate adjustments; Official financing; OMT (search for similar items in EconPapers)
JEL-codes: F32 F41 G12 H63 (search for similar items in EconPapers)
Date: 2015
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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Working Paper: The Importance of Trade and Capital Imbalances in the European Debt Crisis (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jpolmo:v:37:y:2015:i:2:p:229-252

DOI: 10.1016/j.jpolmod.2015.02.001

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