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Sectoral allocation and macroeconomic imbalances in EMU

Niels Gilbert and Sebastiaan Pool

DNB Working Papers from Netherlands Central Bank, Research Department

Abstract: In the decade following the introduction of the euro, many Southern EMU members experienced sizeable capital inflows. We document how, instead of contributing to convergence, these flows mainly fueled growth of the nontradable sectors. We rationalize these developments using a tractable two-sector, two-region ('North' and 'South') model of a monetary union. We show how the sharp fall in Southern interest rates that occurred in the run-up to EMU, leads to a consumption boom, wage growth, growth of the nontradable sector, and a deteriorating external position. In the North, an opposite process occurs. As such, both real exchange rates and external positions of the two regions diverge. Including a third country with a flexible exchange rate vis-à-vis the euro amplifies the effects of monetary integration in the South, while dampening them in the North. Using a panel-BVAR, we confirm empirically that the euro area countries experiencing a fall in interest rates relative to the euro area average, experienced faster growth of the nontradable sector and a deteriorating current account balance. We investigate various policy reforms to speed up the necessary rebalancing process. A deepening of the European market shows most promise, boosting GDP growth while facilitating a rebalancing towards tradables.

Keywords: EMU; monetary integration; current account imbalances; sectoral allocation (search for similar items in EconPapers)
JEL-codes: F32 F34 F36 F45 (search for similar items in EconPapers)
Date: 2016-12
New Economics Papers: this item is included in nep-eec, nep-mac, nep-mon and nep-opm
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Persistent link: https://EconPapers.repec.org/RePEc:dnb:dnbwpp:536

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