## Progress Towards External Adjustment in the Euro Area Periphery and the Baltics

_IMF Working Papers, July 22, 2014_

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## Bibliographic details
- Authors: Joong S Kang, Jay C Shambaugh
- Published: July 22, 2014
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781498364713.001

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### Main findings
- The euro area periphery countries and the Baltic countries had large current account deficits in the run-up to the crisis and needed adjustment of relative prices to achieve both internal and external balances.
- Tangible progress has been made through lower wages and/or higher productivity relative to trading partners (“internal devaluation”), contributing to narrowing current account deficits and shifting output towards the tradables sector.
- Some early adjusters cut wages more rapidly followed by productivity improvement; others have only slowly improved productivity largely through labor shedding.
- For most countries the adjustment has come along with a substantial recession as the unit labor cost improvement has largely come from falling employment and much of the current account improvement from import compression.

### Adjustment mechanisms and channels
- “Internal devaluation” via lower wages and/or higher productivity relative to trading partners.
- Productivity improvement following wage cuts for some countries.
- Slow productivity gains achieved largely through labor shedding for other countries.
- Current account improvement achieved in large part through import compression.

### Outcomes, costs, and remaining challenges
- Adjustment has shifted output towards the tradables sector.
- The adjustment process has been associated with a substantial recession in most countries.
- Going forward, countries still need to:
  - generate growing tradables sector employment, and
  - continue adjustment to prevent imbalances from returning as output gaps close.

### Policy implications and recommendations
- Sustain measures that support productivity improvements in tandem with wage adjustments where needed.
- Promote policies that foster employment growth in the tradables sector to replace labor shedding-driven gains.
- Continue adjustment efforts as output gaps close to avoid re-emergence of current account imbalances.

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/progress-towards-external-adjustment-in-the-euro-area-periphery-and-the-baltics-41774_