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Current account imbalances in the Euro area: Competitiveness or financial cycle?

Mariarosaria Comunale and Jeroen Hessel ()

DNB Working Papers from Netherlands Central Bank, Research Department

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 (search for similar items in EconPapers)
JEL-codes: E32 F32 F41 F44 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-acc, nep-cba, nep-eec, nep-mac and nep-opm
Date: 2014-10
References: View references in EconPapers View complete reference list from CitEc
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Persistent link: https://EconPapers.repec.org/RePEc:dnb:dnbwpp:443

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