Adjustment in Euro Area Deficit Countries: Progress, Challenges, and Policies
Staff Discussion Notes, July 14, 2014
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Bibliographic details
- Authors: Thierry Tressel, Shengzu Wang, Joong S Kang, Jay C Shambaugh, Jörg Decressin, Petya Koeva Brooks
- Published: July 14, 2014
- Series: Staff Discussion Notes
- DOI: https://doi.org/10.5089/9781498373814.006
Overview
- Focus: Rebalancing of euro area “deficit economies” — Greece, Ireland, Portugal, and Spain — that accumulated large current account deficits and external liability positions before the crisis.
- Main conclusion: Relative price adjustments have proceeded gradually, supporting rebalancing but accompanied by subdued activity and high unemployment in deficit economies.
Key findings
- Real effective exchange rates have depreciated by 10-25 percent.
- Depreciation has been driven largely by reductions in unit labor costs due to labor shedding.
- Exports have typically rebounded, but subdued demand accounts for much of the reduction in current account deficits.
- The current account balance of the euro area as a whole has shifted into surplus.
- Internal rebalancing has come with subdued activity and notably very high unemployment in the deficit economies, making continued adjustment more difficult.
Mechanisms of adjustment
- Relative price changes: gradual real depreciation in deficit countries (10-25 percent) via lower unit labor costs.
- External channel: export rebounds have contributed to narrowing deficits.
- Domestic demand channel: subdued domestic demand has been a major factor reducing current account deficits.
Costs and challenges
- Adjustment has been associated with subdued overall activity.
- Very high unemployment in deficit economies poses social and economic constraints on further adjustment.
- Continued rebalancing is made more difficult by weak demand and constrained financial intermediation.
Policy recommendations
- Macroeconomic policy:
- Support demand and bring inflation in line with the ECB’s medium-term price stability objective.
- EMU reforms:
- Continue EMU reforms (banking union) to ensure proper financial intermediation.
- Structural reforms:
- Implement structural reforms in product and labor markets to improve productivity and support reallocation of resources to tradable sectors.
IMF Staff Discussion Note “Adjustment in Euro Area Deficit Countries: Progress, Challenges, and Policies” by Thierry Tressel, Shengzu Wang, Joong S Kang, Jay C Shambaugh, Jörg Decressin, and Petya Koeva Brooks, July 14, 2014.