Staff Discussion Notes

Adjustment in Euro Area Deficit Countries: Progress, Challenges, and Policies

By Thierry Tressel, Shengzu Wang, Joong S Kang, Jay C Shambaugh, Jörg Decressin, Petya Koeva Brooks

July 14, 2014

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Thierry Tressel, Shengzu Wang, Joong S Kang, Jay C Shambaugh, Jörg Decressin, and Petya Koeva Brooks. Adjustment in Euro Area Deficit Countries: Progress, Challenges, and Policies, (USA: International Monetary Fund, 2014) accessed December 6, 2024

Disclaimer: This Staff Discussion Note represents the views of the authors and does not necessarily represent IMF views or IMF policy. The views expressed herein should be attributed to the authors and not to the IMF, its Executive Board, or its management. Staff Discussion Notes are published to elicit comments and to further debate.

Summary

Imbalances within the euro area have been a defining feature of the crisis. This paper provides a critical analysis of the ongoing rebalancing of euro area “deficit economies” (Greece, Ireland, Portugal, and Spain) that accumulated large current account deficits and external liability positions in the run-up to the crisis. It shows that relative price adjustments have been proceeding gradually. Real effective exchange rates have depreciated by 10-25 percent, driven largely by reductions in unit labor costs due to labor shedding. While exports have typically rebounded, subdued demand accounts for much of the reduction in current account deficits. Hence, the current account balance of the euro area as a whole has shifted into surplus. Internal rebalancing has come with subdued activity—notably very high unemployment in the deficit economies—and made continued adjustment more difficult. To advance rebalancing further, the paper emphasizes the need for: (1) macroeconomic policies that support demand and bring inflation in line with the ECB’s medium-term price stability objective; (2) continued EMU reforms (banking union) to ensure proper financial intermediation; and (3) structural reforms in product and labor markets to improve productivity and support the reallocation of resources to tradable sectors.

Subject: Balance of payments, Banking, Current account, Current account deficits, Output gap, Potential output, Price adjustments, Prices, Production

Keywords: Area country, Competitiveness, Countries vis-à-vis, Crisis, Current account, Current account deficits, Deficit country, Deficit economy, Euro Area, External stability, Financial system, Global, Labor market, Output gap, Potential output, Price adjustments, Rebalancing, SDN, Structural reforms

Publication Details

  • Pages:

    34

  • Volume:

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  • DOI:

    ---

  • Issue:

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  • Series:

    Staff Discussion Notes No. 2014/007

  • Stock No:

    SDNEA2014007

  • ISBN:

    9781498373814

  • ISSN:

    2617-6750