Why the current account may matter in a monetary union: lessons from the financial crisis in the euro area

Abstract

Introduction The euro was ten years old in 2008. To celebrate this important birthday the European Commission produced a 350-page report (European Commission, 2008), accompanied by a string of research papers, to evaluate the European Monetary Union (EMU) experience after a decade. Lights and shades emerged from a careful and thorough analysis of the relevant issues, but the overall conclusion was that EMU is ‘a resounding success’. Though perhaps more soberly, most observers would have subscribed to this view, ready to shelve some issues that, hotly debated when EMU was first launched, seemed now to have lost relevance: the effects of asymmetric shocks when optimum currency area conditions are not satisfied, the dangers of uncoordinated fiscal policies, the Walters (1986) critique of a ‘one-size-fits-all’ single monetary policy. One of the questions examined in the report, and at first sight somewhat reminiscent of the issues raised by Sir Alan Walters, was that of persistent differences in growth and inflation between some countries and the rest of the euro area. Misgivings on the sustainability of these trends were expressed here and there, but on the whole the policy conclusion was broadly reassuring: The performance of [Spain, Ireland and Greece] has…shown a satisfactory development overall…The strong performers have been thriving on investment booms spurred by capital inflows attracted by comparatively high rates of return, with the single currency and the integration of financial markets acting as a catalyst…Overall the divergences in growth and inflation have been long-lasting, involving major shifts in intra-euro-area real effective exchange rates…This has been reflected in divergent current account positions across countries. Some, but not all, elements of these differences in inflation, growth and external positions can be attributed to structural convergence in living standards. Even so, not all inflation differentials are harmful; some are merely a sign that competitiveness realignment is doing its job. (European Commission, 2008)

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