Current Account Adjustment in the Eurozone: Lessons From a Flexible Price Model

• Date: 01 July 2016
• DOI: http://doi.org/10.1111/twec.12309
• Author: Christoph Zwick
• Published date: 01 July 2016

Current Account Adjustment in the

Eurozone: Lessons From a Flexible Price

Model

Christoph Zwick

Department of Economics, University of Graz, Graz, Austria

1. INTRODUCTION

THE period preceding the ongoing economic crisis was characterised by large current

account imbalances among the important blocks in world economy. As demonstrated in

Figure 1, global imbalances nearly tripled from 2 per cent of world GDP in the beginning of

the 1990s to 6 per cent in 2006. This formation was driven primarily by the US current

account deficit which peaked at 800 billion US dollars in 2006 and the corresponding sur-

pluses in emerging Asia and the oil-exporting countries.

Reducing global imbalances has been broadly recognised as essential aspect of restoring

economic growth (see, e.g., Blanchard and Milesi-Ferretti, 2012, for a discussion). In

response, the G-20 launched an initiative to reduce global imbalances which is part of the

‘mutual assessment process’ (MAP), a ‘roadmap’ designed to promote a sustainable recovery

from the current economic crisis (for details, see Faruqee and Srinivasan, 2012). The MAP

recognises that global current account rebalancing requires primarily shifts in relative demand

between deficit and surplus regions; that is, deficit countries need to reduce domestic demand

while surplus countries need a proportionate increase. In a perfectly integrated world, this

would wipe out global imbalances and leave aggregate demand for goods and services of each

region unchanged. Once considering trade frictions, shifts in relative demand induce move-

ments in relative prices since the resulting ‘home bias’ in the consumption of domestic trad-

able goods then creates a disproportionate increase in demand for products of surplus regions

(Obstfeld and Rogoff, 2000, 2005, 2007). If the accompanying shifts in real exchange rates

come about with a lag or are of insufficient magnitude, deficit regions suffer from a shortfall

in demand which negatively affects output and employment.

In contrast to the United States and Asia, Europe and the European Monetary Union as a

whole exhibit a nearly balanced current account over the last decade (Figure 2). This aggre-

gate view yet hides the evolution of severe current account imbalances within the Eurozone

which, excluding Ireland, follow a North–South divide. Substantial current account deficits in

Greece, Italy, Portugal and Spain (GIPS/periphery countries) are mirrored by surpluses in core

countries, particularly in Germany. According to Chen et al. (2012), the deterioration of cur-

rent account-to-GDP ratios in the Eurozone periphery (see Figure 3) can be explained by fast

rising wages in this region, a nominal appreciation of the Euro, the financial integration fol-

lowing the introduction of the common currency and the rising importance of emerging Asia

and eastern European countries in the world economy. While the latter brought stron ger com-

I am deeply grateful to Prof. J€

orn Kleinert for his support in several stages of the development of this

paper. I furthermore want to thank Max G€

odl for his useful comments. Finally, I want to thank all

members of the department of economics in Graz who supported this final version with useful hints and

critical remarks on earlier versions.

©2015 John Wiley & Sons Ltd 1025

The World Economy (2016)

doi: 10.1111/twec.12309

The World Economy

petition for products of periphery countries, German exporters benefited from stronger import

demand resulting from increased purchasing power in those regions. As a result, real effective

exchange rates of periphery countries appreciated sharply (compare figure 4) and net interna-

tional investment positions (NIIP) deteriorated. According to most recent data from the IMF

International Investment Position Database, Portugal (116 per cent), Greece (121.1 per

cent), and Spain (92.6 per cent) face a negative NIIP of close to 100 per cent and more of

0.00%

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

1.00%

2.00%

3.00%

4.00%

5.00%

6.00%

7.00%

FIGURE 1

Global Imbalances as Percentage of World GDP 1990–2012

(Sum of Absolute Values of Current Account Deficits and Surpluses)

Source: IMF World Economic Outlook Database, December 2012 (2012 values are estimates).

–

3.00%

–

2.00%

–

1.00%

0.00%

1.00%

2.00%

3.00%

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

EMU-Surplus GIPS Total

FIGURE 2

Current Account Imbalances as Percentage of Eurozone GDP 2001–12

Source: IMF World Economic Outlook Database, December 2012 (2012 values are estimates).

©2015 John Wiley & Sons Ltd

1026 C. ZWICK