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Do current account deficits matter inside a monetary union?
Do current account deficits matter inside a monetary union?
The answers are “no” and “yes”:
no, because there cannot be a currency crisis;
and yes, because there cannot be a currency crisis.
Martin Wolf, FT 28/3 2007
Where unsustainable divergences in competitiveness emerge, adjustment occurs largely through changes in relative nominal costs, particularly of labour.
The bigger the required adjustment, the greater the pain.
Between 2001 and 2005 eurozone growth averaged a mere 1.4 per cent a year.
In response, the European Central Bank adopted an expansionary monetary policy.
But the impact of low interest rates was greatest not where demand was weakest, but where conditions for a property boom were best: notably, in Ireland and Spain
“So what?” one may reasonably ask. Why should the emergence of so-called imbalances inside the eurozone be of any greater significance than the balance of payments between Scotland and England?
Indeed, are the huge capital flows that are the counterpart of the current account surpluses and deficits not what the creation of a currency union is designed to achieve?
Inside a monetary union, currency risk turns into credit risk. Again, even widespread bankruptcy may not matter much if wages and prices are reasonably flexible in nominal and real terms, or it is easy to expand production of competitive tradeable goods and services. Adjustment then is relatively straightforward, as experience in east Asian and Nordic economies has shown in the not too distant past.
In such cases it is at least relatively easy to replace the lost domestic demand with foreign demand. But it is hard to be confident that this would be true of Spain when the property and construction booms end
A decade or so from today we should have a far better idea than today of how far one of Europe’s hitherto most successful economies is able to thrive within the straitjacket of the currency union.
straitjacket = tvångströja
Comment by Rolf Englund:
Yeahh, One Size does not fit all.