Persistent macroeconomic imbalances in the Euro area: causes and consequences

Abstract

In this paper, the authors document a growing divergence between current account imbalances in northern and southern euro area countries from 1992 to 2007. The imbalance occurred without a con-comitant rise in productivity and growth in the southern (deficit) countries. The authors argue that sys-tematic monitoring of external imbalances and implementation of better coordinated policies to prevent the emergence of unsustainably large imbalances in the euro area is advisable because (i) country hetero-geneity and the absence of optimal currency area characteristics may lead to the emergence of large cur-rent account imbalances without automatic gains in productivity and economic growth to sustain these imbalances, (ii) the absence of sufficient market-based adjustment mechanisms substantially increases the costs of ultimate adjustment toward more sustainable current account positions, and (iii) large exter-nal imbalances—particularly through the major role of the banking system—potentially have strong negative consequences for fiscal policy. (JEL F15, F32, F41) Federal Reserve Bank of St. Louis Review, January/February 2012, 94(1), pp. 1-20. January 1, 1999, marked the start of the euro area and the introduction of the euro as the common currency for 11 European Union (EU) members.1 At the time, this was perceived as the final step in the European economic and monetary integration process. The Europea