Germany’s central bank has weighed in on a thorny topic in Europe: whether the euro has made it harder for countries in the currency to adjust their current account imbalances.
The Bundesbank‘s conclusion: it has, and could create problems for the currency bloc down the road.“Current account adjustment is significantly hampered in countries that are members of a monetary union,” a pair of Bundesbank economists concluded in a paper published Monday by the central bank.
If imbalances prove persistent, “ultimately, this could increase the risk of a balance of payments crisis going hand in hand with capital reversals. That is what we actually found in the data,” authors Sabine Herrmann and Axel Jochem wrote.
The economists combed data from 1994 to 2011 for all 27 countries in the European Union, which includes those both inside and outside the 17-nation euro bloc.
The analysis captures countries with flexible exchange rates as well as those with fixed exchange rates that also have more leeway on interest rates with their own monetary policies.
The current account is comprised mostly of the trade balance in goods and services, but also includes income on investments. When these deficits rise, a normal adjustment is for a country’s currency to depreciate.
That gives a lift to exports, which become more price competitive in global markets. The downside is more inflation.
“The exchange rate regime does indeed matter for the pace of current account adjustment,” the authors wrote. Individual euro countries don’t have that foreign-exchange channel as much as they did before the joining the single currency.
The euro has been well above its long-term average over the past few years despite high trade and current account deficits in southern Europe.
Stronger countries in the north such as Germany, Austria and the Netherlands run large surpluses, which evens things out. In other words: the euro may be too strong for Spain, Italy and Greece and too low for Germany.
The Bundesbank economists estimate that in countries with freely floating exchange rates, half of a potential current-account imbalance is eliminated in one year.
“By contrast, current account rebalancing is by far the slowest within a country joining a monetary union: the rate of rebalancing within a year is just 24%,” they wrote.
Still, many of the euro zone’s crisis-hit members have managed to bring down large current account deficits despite being handcuffed by the euro. Spain’s gap was nearly 10% of GDP in 2008. It’s expected to be in surplus this year for the first time since the mid-80s.
Greece has cut its deficit from 15% of GDP in 2008, and it’s nearly in balance now. Portugal is also down from double-digit deficits to near balance. These trends aren’t necessarily at odds with Bundesbank’s findings.
Deficits have come down, but it’s been a long process with some severe consequences in parts of Europe. Spain’s adjustment was aided by sharply rising exports.
But in general, the current account balances have been brought into line through steep drops in domestic demand, reducing imports. The result is soaring unemployment in southern Europe, stagnant wages and flat or declining consumer prices.
That suggests any pronounced economic recovery is a ways off even if the ledgers look better. And the risks from the current account aren’t over, the Bundesbank paper suggests, despite stability in euro zone interest rates.
“We cannot rule out the possibility that a delayed adjustment process might lead to a balance of payments crisis with a sudden and disorderly current account adjustment in euro-area member countries,” the authors wrote.
“This is due to the fact that the degree of exchange rate as well as interest rate volatility in the crisis period is to a large extent determined by the amount of external assistance,” they said.
Emergency measures set up by the currency bloc have cushioned stabilized markets, they wrote, “but at the same time may hamper structural adjustment if they are insufficiently embedded in political reforms.”
wsj.com
The Bundesbank‘s conclusion: it has, and could create problems for the currency bloc down the road.“Current account adjustment is significantly hampered in countries that are members of a monetary union,” a pair of Bundesbank economists concluded in a paper published Monday by the central bank.
If imbalances prove persistent, “ultimately, this could increase the risk of a balance of payments crisis going hand in hand with capital reversals. That is what we actually found in the data,” authors Sabine Herrmann and Axel Jochem wrote.
The economists combed data from 1994 to 2011 for all 27 countries in the European Union, which includes those both inside and outside the 17-nation euro bloc.
The analysis captures countries with flexible exchange rates as well as those with fixed exchange rates that also have more leeway on interest rates with their own monetary policies.
The current account is comprised mostly of the trade balance in goods and services, but also includes income on investments. When these deficits rise, a normal adjustment is for a country’s currency to depreciate.
That gives a lift to exports, which become more price competitive in global markets. The downside is more inflation.
“The exchange rate regime does indeed matter for the pace of current account adjustment,” the authors wrote. Individual euro countries don’t have that foreign-exchange channel as much as they did before the joining the single currency.
The euro has been well above its long-term average over the past few years despite high trade and current account deficits in southern Europe.
Stronger countries in the north such as Germany, Austria and the Netherlands run large surpluses, which evens things out. In other words: the euro may be too strong for Spain, Italy and Greece and too low for Germany.
The Bundesbank economists estimate that in countries with freely floating exchange rates, half of a potential current-account imbalance is eliminated in one year.
“By contrast, current account rebalancing is by far the slowest within a country joining a monetary union: the rate of rebalancing within a year is just 24%,” they wrote.
Still, many of the euro zone’s crisis-hit members have managed to bring down large current account deficits despite being handcuffed by the euro. Spain’s gap was nearly 10% of GDP in 2008. It’s expected to be in surplus this year for the first time since the mid-80s.
Greece has cut its deficit from 15% of GDP in 2008, and it’s nearly in balance now. Portugal is also down from double-digit deficits to near balance. These trends aren’t necessarily at odds with Bundesbank’s findings.
Deficits have come down, but it’s been a long process with some severe consequences in parts of Europe. Spain’s adjustment was aided by sharply rising exports.
But in general, the current account balances have been brought into line through steep drops in domestic demand, reducing imports. The result is soaring unemployment in southern Europe, stagnant wages and flat or declining consumer prices.
That suggests any pronounced economic recovery is a ways off even if the ledgers look better. And the risks from the current account aren’t over, the Bundesbank paper suggests, despite stability in euro zone interest rates.
“We cannot rule out the possibility that a delayed adjustment process might lead to a balance of payments crisis with a sudden and disorderly current account adjustment in euro-area member countries,” the authors wrote.
“This is due to the fact that the degree of exchange rate as well as interest rate volatility in the crisis period is to a large extent determined by the amount of external assistance,” they said.
Emergency measures set up by the currency bloc have cushioned stabilized markets, they wrote, “but at the same time may hamper structural adjustment if they are insufficiently embedded in political reforms.”
wsj.com
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