## _wp14131

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---

### Introduction and context
- On the eve of the global financial crisis, the euro area periphery countries and the Baltic countries faced large and growing current account deficits.
- Because these countries use the euro (or fix to the euro), devaluation had to be achieved via a fall in domestic prices relative to trading partners’ prices ("internal devaluation").
- Internal devaluation objectives include:
  - shifting spending towards domestic goods and services;
  - reorienting productive resources to the tradables sector; and
  - increasing output to potential levels.
- Two dimensions of price adjustment required:
  - (i) a fall of relative price of non-tradables to tradables to reorient production towards tradables, and
  - (ii) a decline of domestic tradables prices relative to foreign tradables to boost exports.

### Key empirical findings
- The paper studies how unit labor cost (ULC) adjustments occurred across countries and sectors and links these adjustments to quantity adjustment.
- Empirical observations:
  - Current account deficits have narrowed significantly and unit labor costs have fallen in every country.
  - Considerable cross-country variation: some early adjusters cut wages more rapidly; others improved productivity more slowly (largely via labor shedding).
  - Countries with large wage run-ups prior to the crisis have experienced more compressing wages after the crisis.
  - Across sectors, in every country but Greece, unit labor costs have declined more in the tradables sector.
  - Real outputs in the tradables sector are higher than pre-adjustment levels in every country but Greece.
  - Employment remains below the pre-crisis level even in the tradables sector in all countries.
  - Low global and regional growth has made adjustment more difficult.
  - Falling costs improved relative international costs and trade shares and volumes have increased.
  - Much of the adjustment has taken place via import compression.
  - Given high unemployment rates, unit labor cost improvement will likely need to continue.

### Overall adjustment and country examples
- Economy-wide patterns:
  - ULC improved across all countries since adjustments began.
  - Except in Greece, productivity gains contributed significantly to improving ULC as labor shedding more than offset output decline.
  - Greece: productivity decreased as decline of real output overwhelmed decline in employment; wage cuts were a key source of ULC improvement.
- Country magnitudes and patterns:
  - Ireland: sustained productivity improvements have kept ULC lower than peak by "15 to 20 percent."
  - Latvia: sharp wage decline initially; subsequent partial wage recovery while productivity continued improving.
  - Lithuania: substantial early wage cuts, followed by productivity improvement with labor shedding and output recovery.
  - Estonia: adjustment largely due to productivity growth through large labor shedding; wages modestly fell at first but by end of sample are above pre-adjustment level.
  - Greece: adjustment started later; wage cuts generate all of the adjustment without productivity improvement; as of end of Q1 2013, productivity still lower than before adjustment began.

### Timing and extent of wage adjustment (regression evidence)
- Methodology: regressions of percentage change of wages over first, second, and third years after adjustment began on pre-adjustment wage growth (disaggregate data for 10 sectors).
- Key regression finding: "Wages fell more, by the second and the third year, in those countries and sectors that experienced higher wage growth in the run-up to the crisis."
- Regression coefficients on precrisis wage growth (significance markers preserved):
  - Controls / 1 year / 2 years / 3 years
  - None: 0 .03** -0.05** -0.05***
  - Country dummies: -0.12*** -0.12** -0.19***
  - Sectoral dummies: 0.004 -0.08** -0.09**
  - Country & sectoral dummies: -0.11** -0.13*** -0.18**
  - With additional control for productivity growth:
    - None: 0.03 -0.04*** -0.06***
    - Country dummies: -0.09** -0.10*** -0.16***
    - Sectoral dummies: 0.01 -0.06*** -0.08***
    - Country & sectoral dummies: -0.10** -0.11** -0.18***
- Notes: *, **, *** indicate statistical significance at 10%, 5%, and 1% levels, respectively.

### Sectoral adjustment (tradables vs non-tradables; public vs private)
- Sectoral classification follows Eurostat/NACE; broad tradables include: "agriculture, forestry & fishing", "industry excluding construction", "trade, travel, accommodation & food", "information & communication", and "financial insurance." Narrow tradables = "industry excluding construction."
- Static sectoral patterns:
  - Wages fell more in the non-tradables sector in every country.
  - In many countries, ULC declined more in the tradables sector driven by larger productivity gains.
  - Real outputs in tradables have surpassed pre-adjustment levels for most countries; outputs in non-tradables remain below pre-adjustment in every country.
  - Employment remains below pre-crisis level even in tradables sector for all countries.
- Country-specific sectoral dynamics (highlights):
  - Estonia: tradables saw immediate productivity gains via large labor shedding; tradable goods recovered quickly with rising wages; public sector wage cuts never more than "10 percent."
  - Latvia and Lithuania: both sectors responded with wage cuts and labor shedding; Latvia’s non-tradables and public sector wage cuts reached nearly "40 percent."
  - Ireland: large wage cuts and labor shedding in both sectors improved ULC; tradables saw substantial output recovery but wages and employment have not fully recovered.
  - Spain and Portugal: later adjustment, largely via productivity gains from labor shedding with little initial wage adjustment; recent wage cuts notably in public sector.
  - Greece: output continues to fall; tradables ULC improvements limited and tradables sector relatively small; non-tradables and public sector ULC improvement driven by wage cuts.

### External performance, REER, exports, and elasticity analysis
- REER changes:
  - Economy-wide ULC-based REER depreciated by "about 10 to 25 percent" since beginning of adjustments.
  - GDP deflator-based REERs depreciated somewhat less than ULC-based REERs, implying relative prices declined less than relative labor costs due to larger profit margins.
  - Nearly all REER depreciation came from improvement in unit labor costs rather than nominal exchange rate depreciations.
- Exports and market shares:
  - Real exports rebounded in response to declining ULCs and recovery of global trade; export volume in every country but Greece recovered and surpassed 2007Q4 levels.
  - Merchandise export market shares fell during the crisis and began to rebound in the Baltics; stabilized in others.
- Trade elasticities and contribution analysis (analysis period: four years after adjustment began; income elasticity = "2"; export and import elasticities w.r.t. REER = ".71" and ".08"):
  - Table 3 country entries (all values in percent, 2008-12 for periphery Europe and 2007-11 for the Baltics):
    - Greece: GDP change -20; REER change -13; CA change 12.0; Predicted CA Change 12; Contribution from REER 22%
    - Ireland: GDP change -4; REER change -22; CA change 10.6; Predicted CA Change 20; Contribution from REER 81%
    - Portugal: GDP change -5; REER change -7; CA change 11.1; Predicted CA Change 4; Contribution from REER 45%
    - Spain: GDP change -5; REER change -12; CA change 8.6; Predicted CA Change 4; Contribution from REER 60%
    - Lithuania: GDP change -6; REER change -8; CA change 10.8; Predicted CA Change 4; Contribution from REER 45%
    - Latvia: GDP change -17; REER change -13; CA change 20.3; Predicted CA Change 19; Contribution from REER 25%
    - Estonia: GDP change -8; REER change -3; CA change 18.1; Predicted CA Change 9; Contribution from REER 19%
  - Interpretation: actual adjustment close to predicted for Latvia and Estonia; larger than predicted in Portugal, Spain, Lithuania; in Ireland predicted adjustment larger than actual due to high export- and import-to-GDP ratios. Generally, less than half of predicted adjustment comes from REER changes; an even smaller portion of actual adjustment is due to REER.

### Where are we now? (cyclically-adjusted current accounts and output gaps)
- Official output gap estimates (2012, percent of potential GDP; Table 4):
  - Greece: IMF -7.7; EC -12.2
  - Ireland: IMF -1.7; EC -1.3
  - Portugal: IMF -3.9; EC -3.5
  - Spain: IMF -3.6; EC -4.6
  - Estonia: IMF -0.1; EC 1.4
  - Latvia: IMF -2.4; EC -1.2
  - Lithuania: IMF -1.2; EC -0.5
- Cyclically-adjusted current account implications:
  - Greece cyclically-adjusted current account deficit estimated at "about 6 to 8 percent of GDP" in 2012 relative to a headline deficit of "about 3 percent."
  - Portugal cyclically-adjusted current account deficit about "3 percent of GDP"; other countries estimated to have relatively small cyclically-adjusted deficits.
- Employment and slack:
  - Employment has declined considerably across all countries and sectors; all countries lost employment even in tradables sector, indicating sizable output gaps.
- Okun-based alternative output gap estimates and implied cyclically-adjusted CA (Table 5; preserved formatting):
  - Long-run unemployment rates / Unemployment rates in June 2013 / Implied output gap / Current account balances in 2012 / Cyclically-adjusted current account balances (in percent)
  - Greece: 15 27 20 - 30 -3 -10 to -15
  - Ireland: 9 14 10 - 15 50
  - Portugal: 10 17 10 - 20 -2 -5 to -10
  - Spain: 15 26 10 - 20 -1 -5 to -10
  - Estonia: 8 8 0 -1 -1
  - Latvia: 10 13 -5 -2 -2 to -5
  - Lithuania: 9 12 -5 -1 -2 to -5
- Interpretation from Okun-based estimates:
  - Current output gaps could be "much more than 10 percent in the euro area periphery countries, and more than 20 percent in Greece."
  - Applying these estimates, cyclically-adjusted current account deficits could still be:
    - "2 to 5 percent" in Latvia and Lithuania,
    - "more than 5 percent of GDP" in Portugal and Spain,
    - "over 10 percent" in Greece,
    - Estonia and Ireland nearly at balance (with exceptions noted).
- Notes and caveats:
  - For lower official output gap estimates to be accurate, long-run unemployment would need to be implausibly high in some countries (e.g., above "20 percent" in Spain and Greece).
  - If long-run unemployment rates in Latvia and Lithuania are as high as "12 percent", they would effectively have no output gap at this time.

### Policy implications and recommendations
- To achieve internal and external balance under fixed exchange rates, policy measures should focus on:
  - achieving internal devaluation via reductions in unit labor costs (wage adjustment and productivity improvements);
  - fiscal reform;
  - productivity-enhancing measures in the tradables sector;
  - improving wage competitiveness;
  - measures to support sustainable adjustment beyond cyclical recovery given a significant cyclical component to current account improvement.
- Emphasis that improving export sector performance is necessary to meet large net income payment needs and to prevent re-emergence of external imbalances as output recovers toward full potential.
- Increasing production and employment in the tradables sector is important given persistently high unemployment rates.
- If output gaps are larger than official estimates, there is more room for growth recovery (beneficial for fiscal adjustment) but more relative price adjustment will be needed to avoid re-emergence of large external imbalances and to reach full employment.

*Source: _wp14131 - References (PDF chapter/section).*

### References .............................................................................................................

### References

### Appendixes
- I. Sectoral Classification
- II. Cyclically-Adjusted Current Account Balances

### I. INTRODUCTION
- On the eve of the global financial crisis, the euro area periphery countries and the Baltic countries faced large and growing current account deficits.
- Literature has pointed to both poor export performance (Chen, Milessi-Ferreti, and Tressel, 2012; Berger and Nitsch, 2010; Bayoumi, Harmsen, and Turunen, 2011) and domestic boom and structural factors (Ivanova, 2012; Lane and Pels, 2012; Jaumotte and Sodsriwiboon, 2010) as underlying causes.
- Kang and Shambaugh (2013) highlight additional non-trade factors including the role of declining transfers and net income balances.
- Regardless of underlying causes, as the crisis hit, these countries needed depreciation to reduce large current account deficits; because they use the euro (or fix to the euro), devaluation had to be achieved via a fall in domestic prices relative to trading partners’ prices ("internal devaluation").
- Internal devaluation objectives include:
  - shifting spending towards domestic goods and services;
  - reorienting productive resources to the tradables sector; and
  - increasing output to potential levels.
- One mechanism for internal devaluation is for tradable goods unit labor costs to fall, making tradables more attractive relative to non-tradables and less expensive than foreign tradable goods.
- More generally, prices need to adjust along two dimensions:
  - (i) a fall of relative price of non-tradables to tradables to reorient production towards tradables, and
  - (ii) a decline of domestic tradables prices relative to foreign tradables to boost exports.

### Literature on postcrisis adjustment under fixed exchange rates
- Five years after the onset of the global financial crisis, many studies analyze postcrisis adjustment in European countries under fixed exchange rates.
- Atoyan, Manning, and Rahman (2013) link differences in current account adjustment between periphery Euro area and emerging Europe countries to savings and investment developments, availability of financing, and the composition of adjustment between exports and imports.
- Bakker and Klingen (2012) provide country-by-country analysis covering scrambles during the crisis, stabilization and recovery, and remaining challenges.
- ECB (2012) studies competitiveness adjustment with model simulations and shows that a fiscal reform, productivity-enhancing measures in tradables sector, and improving wage competitiveness would contribute to external balance improvement.
- Nkusu (2013) finds boosting and maintaining both price and non-price competitiveness would be critical for Ireland to return to strong growth and low imbalances.
- Tressel and Wang (2013) note that a significant share of current account adjustment appears to be driven by cyclical factors, suggesting more needs to be done to make the adjustment sustainable.

### Key findings and empirical results reported in this content unit
- The paper studies how unit labor cost adjustments have been made across countries and sectors and links these adjustments to quantity adjustment.
- Empirical observations:
  - Current account deficits have narrowed significantly in these economies and unit labor costs have fallen in every country.
  - There has been considerable variation in the adjustment process across countries since the global financial crisis began: some early adjusters cut wages more rapidly while others improved productivity more slowly (largely through labor shedding).
  - Comparing wage dynamics before and after the crisis, countries with large wage run-ups prior to the crisis have experienced more compressing wages after the crisis.
  - Across sectors, in every country but Greece, unit labor costs have declined more in the tradables sector.
  - Real outputs in the tradables sector are higher than pre-adjustment levels in every country but Greece.
  - Employment remains below the pre-crisis level even in the tradables sector in all countries, implying internal devaluation is taking place against the backdrop of a sustained recession.
  - Low global and regional growth is making the adjustment far more difficult.
  - Falling costs have led to improved relative international costs and trade shares and volumes have increased.
  - Much of the adjustment has taken place via import compression.
  - Given high unemployment rates, unit labor cost improvement will likely need to continue for both internal and external adjustment.

### Policy implications and recommendations highlighted
- To achieve internal and external balance under fixed exchange rates, policy measures should focus on:
  - achieving internal devaluation via reductions in unit labor costs (wage adjustment and productivity improvements);
  - fiscal reform;
  - productivity-enhancing measures in the tradables sector;
  - improving wage competitiveness;
  - measures to support sustainable adjustment beyond cyclical recovery given a significant cyclical component to current account improvement.
- Emphasis that improving export sector performance is necessary to meet large net income payment needs and to prevent re-emergence of external imbalances as output recovers toward full potential.
- Increasing production and employment in the tradables sector is important given persistently high unemployment rates.

### Structure of the paper (as described)
- Section II discusses the adjustment of unit labor costs in the overall economy focusing on both static and dynamic aspects.
- Section III presents empirical results linking postcrisis wage adjustment to precrisis developments.
- Subsequent discussion covers adjustment of unit labor costs across different sectors and implications.

*Source: _wp14131 - References*

### Section IV, followed by quantity responses to these price adjustment in Section V. Section

### _wp14131 - Section IV, followed by quantity responses to these price adjustment in Section V. Section

### Overall adjustment
- Current account deficits have narrowed significantly across these countries over the last five years.
- Improvement in external positions has been associated with large decline in output and sharp increase of unemployment; five years since the onset of the crisis, output still remains below potential and unemployment rates are in double digits in 2012.
- Static adjustment of unit labor costs (ULC):
  - Unit labor costs have improved across all countries since they began adjustment.
  - Except in Greece, productivity gains have made significant contributions to improving ULC as large labor shedding more than offset output decline.
  - For Greece, productivity has decreased as the decline of real output has overwhelmed the decline in employment.
  - In some countries such as Greece and Latvia, large wage cuts contributed significantly to improving ULC during the adjustment period.
- Country examples and magnitudes:
  - Ireland: sustained productivity improvements have kept ULC lower than peak by "15 to 20 percent."
  - Latvia: sharp wage decline initially; subsequently wages recovered to some extent while productivity continued improving.
  - Lithuania: substantial wage cuts early, followed by productivity improvement with labor shedding and output recovery.
  - Estonia: adjustment largely due to productivity growth through large labor shedding in early periods and output recovery in recent years; wages modestly fell at first but by end of sample are above pre-adjustment level.
  - Greece: adjustment started much later; wage cuts generate all of the adjustment without improvement in labor productivity; as of end of Q1 2013, productivity still lower than before adjustment began.

### Timing and extent of wage adjustment
- Methodology:
  - Regressed percentage change of wages over first, second, and third years after adjustment began (2007Q4 for Baltics, 2008Q4 for euro area periphery) on wage growth from 2000Q1 to start of adjustment.
  - Disaggregate data for 10 sectors used; specification: Δw_is_post = α + β * Δw_is_pre + controls + u_is.
- Key regression findings:
  - "Wages fell more, by the second and the third year, in those countries and sectors that experienced higher wage growth in the run-up to the crisis."
  - Results are more apparent when controlling for country or sector.
  - Results hold when including productivity growth both prior to and after the crisis.
  - Interpretation: countries/sectors with more excess wage growth pre-crisis experienced more wage declines during adjustment; Baltics and Ireland may have had more flexibility to cut wages.
- Regression coefficient table (coefficients on precrisis wage growth; significance markers preserved):
  - Controls / 1 year / 2 years / 3 years
  - None: 0 .03** -0.05** -0.05***
  - Country dummies: -0.12*** -0.12** -0.19***
  - Sectoral dummies: 0.004 -0.08** -0.09**
  - Country & sectoral dummies: -0.11** -0.13*** -0.18**
  - With additional control for productivity growth:
    - None: 0.03 -0.04*** -0.06***
    - Country dummies: -0.09** -0.10*** -0.16***
    - Sectoral dummies: 0.01 -0.06*** -0.08***
    - Country & sectoral dummies: -0.10** -0.11** -0.18***
  - Notes: *, **, *** indicate statistically significant coefficients with 10%, 5%, and 1% confidence levels, respectively.

### Sectoral adjustment (tradables vs non-tradables; public vs private)
- Construction of sectoral ULC follows Eurostat methodology; sectoral classification uses NACE; tradables (broad) include: "agriculture, forestry & fishing", "industry excluding construction", "trade, travel, accommodation & food", "information & communication", and "financial insurance." All other sectors including public sector classified as non-tradables. Narrow tradable goods measure = "industry excluding construction."
- Static sectoral patterns:
  - Wages fell more in the non-tradables sector in every country.
  - In many countries, ULC declined more in the tradables sector driven by larger productivity gains.
  - Real outputs in tradables sector have surpassed pre-adjustment levels for most countries (blue columns negative), particularly Estonia and Ireland; outputs in non-tradables sector remain below pre-adjustment in every country.
  - Employment remains below pre-crisis level even in tradables sector for all countries.
- Dynamics and country-specific patterns:
  - Estonia:
    - Tradables: large labor shedding initially; output fell less than employment → immediate productivity gains.
    - Non-tradables: wages fell initially; employment declined sizably from following quarter; public sector relied largely on wage cuts (never more than "10 percent").
    - Tradable goods recovered quickly with significant rebound in output and rising wages; overall employment losses more than halved over recent periods.
  - Latvia and Lithuania:
    - Both sectors responded to output collapse via wage cuts and labor shedding; Latvia’s wage cuts far exceeded other early adjusters (non-tradables and public sector wage cuts dramatic—reaching nearly "40 percent").
    - Output recovery in tradables occurred but less than Estonia; employment has begun to recover with wages reaching pre-adjustment levels in recent periods.
  - Ireland:
    - Large wage cuts and labor shedding in both sectors improved ULC, leading to substantial output recovery in tradables, but not yet to improvement in wages and employment even in tradables.
    - Non-tradables continued to contract, leading to rising ULC there in recent quarters.
  - Spain and Portugal:
    - Adjustment began later; largely based on productivity gains via large labor shedding with little wage adjustment initially.
    - Spain: productivity improved in tradables during initial period but output began to fall after 2010; employment continued to decline; no initial wage reductions (wages up slightly in tradables despite job losses); very recently wage cuts have contributed, particularly in public sector.
    - Portugal: similar pattern; accelerating pace of declining employment while output began to fall in recent periods; large labor shedding mainly in private sector; public sector counts largely on wage cuts.
  - Greece:
    - Output continues to fall; ULC in tradables has not shown sustained improvement (falling wages and employment offset by output contraction).
    - Tradable goods sector saw ULC declines due to large employment cuts but is a relatively small sector.
    - Non-tradables and public sectors: wage cuts drove ULC improvement; neither tradables nor non-tradables show output recovery.

### External performance
- Real effective exchange rates (REER):
  - Economy-wide ULC-based REER depreciated by "about 10 to 25 percent" since beginning of adjustments.
  - GDP deflator-based REERs also depreciated, though somewhat less than ULC-based REERs, implying relative prices declined less than relative labor costs due to larger profit margins.
  - Nearly all REER depreciation came from improvement in unit labor costs rather than nominal exchange rate depreciations.
- Export quantities and market shares:
  - Real exports rebounded in response to declining ULCs and recovery of global trade; export volume in every country but Greece recovered and surpassed 2007Q4 levels.
  - Merchandise export market shares (Table 2, in percent) — selected entries by year series provided in the source (1999–2012 table preserved in source).
  - Global merchandise export market share fell during the crisis and began to rebound in the Baltics; stabilized in others.
- Trade elasticities and contribution analysis (Table 3):
  - Analysis period: four years after beginning of adjustment (2008–2012 for periphery; 2007–2011 for Baltics).
  - Applied income elasticity toward trade balance = "2"; export and import elasticities w.r.t. REER = ".71" and ".08" respectively (IMF CGER methodology).
  - Table 3 (numbers preserved from source; all values in percent, 2008-12 for periphery Europe and 2007-11 for the Baltics):
    - Greece: GDP change -20; REER change -13; CA change 12.0; Predicted CA Change 12; Contribution from REER 22%
    - Ireland: GDP change -4; REER change -22; CA change 10.6; Predicted CA Change 20; Contribution from REER 81%
    - Portugal: GDP change -5; REER change -7; CA change 11.1; Predicted CA Change 4; Contribution from REER 45%
    - Spain: GDP change -5; REER change -12; CA change 8.6; Predicted CA Change 4; Contribution from REER 60%
    - Lithuania: GDP change -6; REER change -8; CA change 10.8; Predicted CA Change 4; Contribution from REER 45%
    - Latvia: GDP change -17; REER change -13; CA change 20.3; Predicted CA Change 19; Contribution from REER 25%
    - Estonia: GDP change -8; REER change -3; CA change 18.1; Predicted CA Change 9; Contribution from REER 19%
  - Interpretation: actual adjustment close to predicted for Latvia and Estonia; larger than predicted in Portugal, Spain, Lithuania; in Ireland predicted adjustment larger than actual due to high export- and import-to-GDP ratios. In general, less than half of predicted adjustment comes from REER changes; given larger actual than predicted adjustment, an even smaller portion of actual adjustment is due to REER.

### Where are we now? (cyclically-adjusted current account and output gaps)
- Official output gap estimates (2012, percent of potential GDP; Table 4):
  - Greece: IMF -7.7; EC -12.2
  - Ireland: IMF -1.7; EC -1.3
  - Portugal: IMF -3.9; EC -3.5
  - Spain: IMF -3.6; EC -4.6
  - Estonia: IMF -0.1; EC 1.4
  - Latvia: IMF -2.4; EC -1.2
  - Lithuania: IMF -1.2; EC -0.5
- Implications:
  - Cyclically-adjusted current account deficit in Greece estimated at "about 6 to 8 percent of GDP" in 2012 relative to a headline deficit of "about 3 percent."
  - Cyclically-adjusted current account deficit in Portugal about "3 percent of GDP"; other countries estimated to have relatively small cyclically-adjusted deficits.
- Employment and slack:
  - Employment has declined considerably across all countries and across sectors (Figures 72–73); all countries lost employment even in tradables sector, suggesting sizable output gaps.
- Okun-based alternative output gap estimates and implied cyclically-adjusted CA (Table 5, values preserved as in source; where formatting in source is condensed, preserved here):
  - Long-run unemployment rates / Unemployment rates in June 2013 / Implied output gap / Current account balances in 2012 / Cyclically-adjusted current account balances (in percent)
  - Greece: 15 27 20 - 30 -3 -10 to -15
  - Ireland: 9 14 10 - 15 50
  - Portugal: 10 17 10 - 20 -2 -5 to -10
  - Spain: 15 26 10 - 20 -1 -5 to -10
  - Estonia: 8 8 0 -1 -1
  - Latvia: 10 13 -5 -2 -2 to -5
  - Lithuania: 9 12 -5 -1 -2 to -5
- Interpretation from Okun-based estimates:
  - Even with relatively high estimates of steady-state unemployment, current output gaps could be much larger: "much more than 10 percent in the euro area periphery countries, and more than 20 percent in Greece" (Table 5 derived estimates).
  - Applying these estimates, cyclically-adjusted current account deficits could still be:
    - "2 to 5 percent" in Latvia and Lithuania,
    - "more than 5 percent of GDP" in Portugal and Spain,
    - "over 10 percent" in Greece,
    - Estonia and Ireland nearly at balance (with exception noted).
- Notes and caveats:
  - For the lower official estimated output gaps to be accurate, long-run unemployment would need to be implausibly high in some countries (e.g., above "20 percent" in Spain and Greece).
  - If long-run unemployment rates in Latvia and Lithuania are as high as "12 percent", they would effectively have no output gap at this time.

### Conclusion (summary of substantive findings and policy-relevant implications)
- Tangible progress has been made in lowering tradables unit labor costs in most countries (except Greece) via lower wages and/or higher productivity relative to trading partners.
- Real exports have rebounded; import compression has also contributed to significant improvement in current account balances.
- However:
  - Employment—even in tradables sector—has not recovered to pre-crisis levels.
  - Unemployment rates remain very high in all countries.
  - Adjustment has not yet triggered broad benefits to overall economies: adjustment is occurring within sustained recessions and is not generating enough demand to strengthen economies.
- Heterogeneity in outcomes is driven by:
  - Different timing of adjustment,
  - Different product mix and geographical exposure,
  - Idiosyncratic shocks (e.g., political crisis and euro exit fears in Greece),
  - Structural factors such as wage bargaining mechanisms.
- Policy implication:
  - If output gaps are larger than official estimates, there is more room for growth recovery (good for fiscal adjustment) but more relative price adjustment will be needed to avoid re-emergence of large external imbalances and to reach full employment.

*Source: IMF staff calculations and analyses in the provided section of the PDF.*

### REFERENCES

### _wp14131 - REFERENCES

### References cited
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### Appendix I: Sectoral classification (European industry standard classification system (NACE))
- Agriculture, Forestry & Fishing
- Private sector
  - Industry
    - Industry excluding construction
      - Manufacturing
    - Construction
  - Service
    - Trade, Travel, Accommodation & Food
    - Information & Communication
    - Financial Insurance
    - Real Estate
    - Professional, Science & Tech
- Public sector
  - Public Admin, Education & Social Work
  - Arts, Entertainment & Recreation

### Appendix II: Cyclically-adjusted current account balances (Okun's Law coefficients and country-level statistics)
Notes:
- 1/ From Ball, Leigh, and Loungani (2013)
- 2/ Truncated to 2.5 if estimated coefficients are higher than 2.5 for conservative calculation
- 3/ For conservative calculation
- (in percent)

Country-specific inputs and results:
- Greece
  - Coefficients that were used in this calculation: 2.5 12.7 8.6 11 15.0 26.9 11.9 29.8
  - Long-run unemployment rates from HP through 2011: -3.1
  - Long-run unemployment rates from HP through 2007 and extension: -15.0
  - Unemployment rates in June 2013: (Implied Output Gap and Current account balances in 2012 not separately labeled in source)
- Ireland
  - Coefficients that were used in this calculation: 2.6 2.5 2.1 4.0 8.9 0.13 5.4 4.5 11.3 4.9 0.4
- Portugal
  - Coefficients that were used in this calculation: 3.8 2.5 2.1 8.9 7.0 10.0 17.4 7.4 18.5 -1.5 -8.9
- Spain
  - Coefficients that were used in this calculation: 1.2 1.2 18.0 8.0 14 15.0 26.3 11.3 13.6 -1.1 -6.5
- Estonia
  - Coefficients that were used in this calculation: 2.4 2.4 8.4 8.4 -0.4 -1.0 -1.2 -0.8
- Latvia
  - Coefficients that were used in this calculation: 2.8 2.5 9.9 10.0 12.5 2.5 6.3 -1.7 -4.2
- Lithuania
  - Coefficients that were used in this calculation: 2.0 2.0 9.2 9.2 11.7 2.5 5.0 -0.5 -2.5

- Cyclically-adjusted Current Account Balances (table heading retained as in source)

*Source: _wp14131 - REFERENCES (PDF chapter/section).*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2014/_wp14131.pdf_