Skip to main content
Log in

Current account and fiscal imbalances in the Eurozone: Siamese twins in an asymmetrical currency union

  • Original Paper
  • Published:
International Economics and Economic Policy Aims and scope Submit manuscript

Abstract

The paper aims at connecting fiscal and external imbalances in the Eurozone. After the shock of the 2007 financial crisis, the current account position was the root cause of discriminatory behavior of foreign lenders towards single countries. Once the interaction between the current account and fiscal imbalances started, the only way out to restore stability and stem capital outflows was to implement fiscal retrenchments and real devaluation. The choice governments of peripheral countries face is therefore, at least in the short run and in recessive conditions, either to restore the equilibrium to their public finance, or to counteract the real shocks coming from the crisis. This suggests to consider that the stability of the Eurozone could be realized at expenses of a lower output in peripheral countries.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Fig. 1
Fig. 2
Fig. 3
Fig. 4
Fig. 5
Fig. 6

Similar content being viewed by others

Notes

  1. This contrasts with the “Keynesian view” according to which fiscal restrictions further increase the deficit/GDP and debt/GDP ratios because of the positive value of the fiscal multiplier. These two contrasting views have re-appeared in recent publications: on the one hand that stability needs to be restored through severe fiscal retrenchment (Neumann 2012). On the other hand, that public investment programs need to be implemented to compensate for the output gap (De Long and Summers 2012). The debate on the effectiveness of austerity measures is synthetically reported in Corsetti (2012).

  2. A great deal has been written on this subject. Here it is worth citing the seminal contribution of Krugman and Rotemberg (1991) for first generation models, Obtstfeld (1986a and 1986b), Kydland and Prescott (1977) for second generation models and Eichengreen and Hausmann (1999)for third generation models. For a review of the content see also Canale et al. (2008).

  3. The European Financial Stability Mehanisms (EFSM) that could lent up to 60 billion Euros with the guarantee of the EU budget and the European financial Stability Facility (EFSF)that could lend up to 440 billion Euros with the guarantee of European Union Member States. Both EFSM and EFSF were not permanent and not based on a written rule of strict conditionality.

  4. In May 2011, the European Council decided that Member States had to present a multi-year repayment plan with the goal of bringing the deficit below 3 % and ensuring the long-term sustainability of public accounts. The text states as follows: “In particular, Member States will present a multi-annual consolidation plan including specific deficit, revenue and expenditure targets, the strategy envisaged to reach the targets and a timeline for its implementation. Fiscal policy for 2012 should aim to restore confidence by bringing debt trends back on a sustainable path and ensuring that deficits are brought back below 3 % of GDP in the timeframe agreed upon the Council. This requires in most cases an annual structural adjustment well above 0.5 % of GDP. Consolidation should be frontloaded in Member States facing very large structural deficits or very high or rapidly increasing levels of public debt” (EU summit 2011). The full text of the EU Summit is available at http://register.consilium.europa.eu/pdf/en/11/st00/st00010.en11.pdf.

  5. Second and third generation models cited in previous pages.

  6. Comparisons have been drawn with the Asian crisis. In the late 90s the growth of the current account deficits in several Asian countries led to the sudden reversal of short-term foreign currency denominated borrowing (Becker and Noone 2008) with capital flows volatility (Forbes and Warnock 2012).

  7. A dynamic version of a risky-return Laffer curve is provided by Bi(2012). The author individuates an endogenous fiscal limit measuring the government’s ability and willingness to service its debt.

  8. Bi (2012) provides microfoundations on how interest rates increase as a function of public debt.

References

  • Alessandrini P., Fratianni M, Hughes Hallett A. and Presbitero A.F., (2012), External Imbalances and Financial Fragility in the Euro Area, MoFIR Working Paper N°66, may

  • Barro RJ (1974) Are government bonds net wealth? J Polit Econ 82(6):1095–1117

    Article  Google Scholar 

  • Barro RJ (1989) The Ricardian Approach to Budget Deficits. J Econ Perspect 3(2):37–54

    Article  Google Scholar 

  • Becker C, Noone C (2008) Volatility and Persistence of Capital Flows. BIS Papers 42. BIS, Basel

    Google Scholar 

  • Berger H and Nitsch V. (2010), The Euro’s Effect On Trade Imbalances, IMF Working Papers n.226

  • Bi H (2012) Sovereign. Default Risk Premia, Fiscal Limits and Fiscal Policy, in “European Economic Review”, 2012 56(3):389–410

    Google Scholar 

  • Blanchard O. and Giavazzi F. (2002), Current Account Deficits in the Euro Area. The End of the Feldstein Horioka Puzzle?, MIT, department of Economics, Working Paper 03–05, September

  • Canale RR, Montagnoli A, Napolitano O (2008) Speculation and monetary policy behaviour in the 1992 currency crisis: the Italian case. Int Econ J 22(3):285–297

    Article  Google Scholar 

  • Cesaratto S. (2012), Controversial And Novel Features Of The Eurozone Crisis as a Balance Of Payments Crisis, Quaderni del Dipartimento di Economia e Statistica, Università di Siena N°640

  • Corsetti G. ed. (2012) Austerity: Too much of a good thing?, CEPR

  • Corsetti G. Müller G. J. (2006) Twin Deficits: Squaring Theory, Evidence and Common Sense, European University Institute, http://www.eui.eu/Personal/corsetti/research/tdh.pdf

  • De Grauwe P. and Yuemei J., (2012), Self-Fulfilling Crises In The Eurozone: An Empirical Test, CeSifo Working Papers N°3821

  • De Grauwe P., (2011), Managing A Fragile Eurozone, CeSifo Forum 2/2011

  • De Long B. and Summers L. (2012), Fiscal Policy in Depressed Economies, Brooking Papers in Economic Activity, march

  • Eichengreen, B. and Hausmann R. (1999). Exchange rate and financial fragility NBER Working Paper, no. 7418, Cambridge, MA

  • European Economy Advisory Group (EEAG) (2012) Report On The European Economy, CeSifo

  • Feldstein M, Horioka C (1980) Domestic Saving and International Capital Flows. Econ J 90:314–329

    Article  Google Scholar 

  • Forbes J. and Warnock F.E., (2012), “Capital Flow Waves: Surges, Stops, Flight And Retrenchment”, Journal of International Economics, march

  • Fratzscher M. (2011), Capital Flows, Push Versus Pull Factors And The Global Financial Crisis, ECB, Working Paper Series No 1364. July

  • Gros D. (2012), Macroeconomic Imbalances in The Euro Area: Symptom or Cause of the Crisis?, CEPS Policy Brief, April N°266

  • Kydland F, Prescott EC (1977) Rules rather than discretion: The inconsistency of optimal plans. J Polit Econ 85(3):473–91

    Article  Google Scholar 

  • Krugman P., and Roteberg J. (1991), Speculative attacks on target zones, in P. Krugman and M. Miller Exchange rate target and currency bands, eds, Oxford University Press

  • Kumhof M. and Laxton D. (2009), Fiscal Deficits and Current Account Deficits, IMF Working Paper N°237

  • Merler S. and Pisani-Ferry J. (2012), Sudden Stops In The Euro Area, Bruegel Policy Contribution March 2012/06.

  • Mundell RA (1961) A Theory of Optimum Currency Areas. Am Econ Rev 51:657–665

    Google Scholar 

  • Neumann, M.J.M.(2012), Too early to sound the alarm, VoxEu, 17 April

  • Obstfeld M, Rogoff K (1995) Exchange rate dynamics redux. J Polit Econ 103(3):624–60

    Google Scholar 

  • Pakko M.R. (2000), Do High Interest Rates Stem Capital Flows?, “Economic Letters” n.67, pp. 187–192

  • Raybaudi M., Sola M., and Spagnolo F. (2004), “Red signals: current account deficits and sustainability”, in, Economics Letters, n.84, pp. 217–223

  • Sinn HW, Wollmershäuser T (2011) “Target Loans, Current Account Balances and Capital Flows: The ECB’s Rescue”, CESifo Working Paper 3500. CESifo, Munich

    Book  Google Scholar 

Download references

Author information

Authors and Affiliations

Authors

Corresponding author

Correspondence to Rosaria Rita Canale.

Electronic supplementary material

Below is the link to the electronic supplementary material.

ESM 1

(XLSX 19 kb)

ESM 2

(WF1 10 kb)

ESM 3

(XLSX 15 kb)

ESM 4

(XLSX 9 kb)

ESM 5

(XLSX 9 kb)

Rights and permissions

Reprints and permissions

About this article

Cite this article

Canale, R.R., Marani, U. Current account and fiscal imbalances in the Eurozone: Siamese twins in an asymmetrical currency union. Int Econ Econ Policy 12, 189–203 (2015). https://doi.org/10.1007/s10368-014-0268-9

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s10368-014-0268-9

Keywords

JEL Classification

Navigation