Current Account ‘Core–Periphery Dualism’ in the EMU

• Author: Tatiana Cesaroni,Roberta De Santis
• Published date: 01 October 2016
• Date: 01 October 2016
• DOI: http://doi.org/10.1111/twec.12418

Current Account ‘Core–Periphery

Dualism’ in the EMU

Roberta De Santis

1

and Tatiana Cesaroni

2

1

Istat - Italian National Institute of Statistics, Rome, Italy and

2

Bank of Italy, Rome, Italy

1. INTRODUCTION

WHILE the current account (CA) of the Eurozone as a whole has remained almost bal-

anced since the 1990s, dispersion across Member States’ CAs has been increasing.

Diverging trends among countries have become particularly evident in the post-EMU period

and have been characterised by persistent CA deficits in the Eurozone periphery that have

been complemented by growing surpluses in some core countries. Such heterogeneous beha-

viour has been called ‘Eurozone CA core–periphery dualism’ and represents a shortcoming

for both the long-run sustainability of peripheral EU Member States’ finances and the effec-

tiveness of centralised intervention within the euro area.

The lack of a spontaneous rebalancing process

1

among euro area economies has stimulated

a wide debate within the European institutions on the absence of proper rules and parameters

such as ceilings for single countries CA imbalances into the existing EU treaties. The need to

implement a stricter degree of policy coordination between the Eurozone members to prevent

such imbalances expanding in the future has also been emphasised, and the adoption of the

Macroeconomic Imbalances Procedure (MIP) within the EMU countries at the end of 2011

goes exactly in this direction.

According to the neo-classical theory of intertemporal utility maximisation, diverging CA

among countries is the natural consequence of a future convergence of economies with differ-

ent levels of capital endowment. Specifically, countries with lower income per capita and

higher productivity growth would be expected to attract foreign investment in view of the

higher expected rates of return on capital. The productivity of the invested capital would

eventually produce CA rebalancing through competitiveness gains in tradable sectors and

reimbursement of the external debt.

Nevertheless, from the beginning of the EMU to the present, there has been no clear evi-

dence of a spontaneous CA rebalancing process within the EMU, despite a strong adjustment

in the external imbalances of the Eurozone peripheral countries during the financial crisis.

The authors would like to thank Riccardo De Bonis, Sergio De Nardis, Marco Ventura, Paolo Savona,

Giuseppe Ferrero and two anonymous referees for their useful comments and suggestions. The authors

also thank participants at the XXVI Villa Mondragone International Economic Seminar, Bank of Italy

and Istat seminars, and INFER-LAREFI workshop on ‘Financial Globalization, International Trade and

Development’ held in Bordeaux for their valuable comments and advice. The views expressed in this

paper are those of the authors and do not necessarily represent the institutions with which they are affili-

ated. Any errors or mistakes remain the authors’ sole responsibility.

1

In the post crisis period (2009–12), there was a substantial adjustment in the external imbalances of

the euro area peripheral countries. However, this rebalancing was mainly due to the decline in domestic

demand and the contraction in private investment, particularly in construction, as a result of the econ-

omic crisis and thus cannot be associated with a good rebalancing process.

©2016 John Wiley & Sons Ltd

1514

The World Economy (2016)

doi: 10.1111/twec.12418

The World Economy

In the literature, various explanations have been proposed for the persistence of CA deficits

among EU periphery members, including, for example, a lack of competitiveness due to high

unit labour costs or unproductive investment in non-tradable sectors (i.e. housing investment).

Blanchard and Giavazzi (2002) offered another interesting explanation immediately after the

creation of the EMU. By analysing the causes of Eurozone imbalances, the authors showed

that national saving and investment correlations in the periphery decreased significantly, espe-

cially as European financial integration intensified (i.e. with the creation of the single cur-

rency). They considered this evidence to be an indication the EMU suitability to create a

well-integrated capital market (i.e. ‘home bias reduction’). They also found that the Feldstein

Horioka puzzle (i.e. the absence of capital outflows from higher income per capita countries

to poorer countries with higher expected returns) did not hold in the Eurozone, interpreting

this fact as an increase of financial integration and a natural cause of CA divergences among

EMU countries

2

that reflected opportunities for catching up and future convergence in the

periphery.

3

To explore the causes of the persistent CA divergences among Eurozone countries, we

investigate the ‘CA core–periphery dualism’ with a particular focus on the role of the Euro-

pean financial integration process. To this end, we examine the impact of capital flows liberal-

isation (in addition to the main CA determinants) within the Eurozone using different time

samples, groups of countries and econometric techniques and control variables. Robustness

checks are also performed by taking into account the role of financial integration using two

different indicators: the Chinn and Ito (2008) index of capital openness (known as the de jure

measure) and a financial diffusion indicator that considers the ratio of financial assets plus lia-

bilities to GDP for each country compared with the rest of the world (a de facto measure);

both are available for a broad set of countries. Although these two capital openness indices

are very different (they capture different aspects of financial development), they allow com-

plementary sources of information on the phenomenon of financial integration to be explored.

Since Blanchard and Giavazzi (2002), a large literature has investigated the determinants of

CA balances for different sets of countries using various regressors (income per capita,

exchange rates, trade openness, net foreign assets, budget balances, GDP growth, population

growth, interest rates, oil price, dependency ratios, financial development measures and insti-

tutional factors).

4

However, to the best of our knowledge, no paper systematically analyses

the CA core and periphery effects of financial integration and capital openness in the Euro-

zone countries.

Among the papers linking CA imbalances to financial integration indicators in the world

economy, Chen and Prasad (2003) analyse the medium-run CA determinants but focusing

mainly on developing countries (18 developed and 72 developing countries) using cross-sec-

tion and panel techniques for the sample 1971–95. They find evidence of a positive impact of

2

This enables easier access to international capital markets of some ‘peripheral’ countries and would

therefore have helped to generate domestic demand pressures that finally led to the accumulation of

large and persistent current account deficits.

3

See Cesaroni et al. (2011) for a description of the main properties of the euro area business cycle and

stylised facts.

4

Income per capita, exchange rates, trade openness, net foreign assets, budget balances, GDP growth,

population growth, interest rates, oil price and dependency ratios are the standard classical determinants

of CA used in the literature. However, some of them have become less significant in explaining the

more recent patterns of CA imbalances in both developing and industrialised countries.

©2016 John Wiley & Sons Ltd

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