2 thoughts on “Current Account Rebalancing in the Euro-Zone: Challenges Ahead?!

  1. Thanks for the great post, it really did clarify a lot of areas in which my understanding was fairly murky. Particularly the comparison with Norway is fascinating. It is also puzzling, at least to me. It would seem that Norway was able use its capital inflows in more “productive” ways than basically all other countries you bring up. Why? And does the answer to that help in figuring out what e.g. Spain should do or have done in the past, other than “hope they find more oil offshore”?.

    You also write that “Empirical articles show that the higher the deficits and debts are, the higher is the probability of a country to experience a “sudden stop” of capital inflows.” Does this imply any causation or just correlation?

  2. Thanks for your reply! I absolutely agree with you on the “productivity-argument”. In terms of Norway the current account deficits financed the development of the oil industry – i.e. an industry which is responsible for the future surpluses. In terms of the United States e.g. the continuous deficits finance(d) a consumption boom from which no such future effect can be expected. So the way that the capital inflows are used definitely matters. To be honest, I cannot fully answer your subsequent question on the way the periphery countries “used” their deficits. In terms of Spain, the construction boom comes to my mind. I think there is some research left the be done on this subject.
    Just a personal remark that I want to add here. Guess it would turn out that the capital inflows were used in a very productive way, but the “sudden stop” prevented investment projects to be succeeded (or imagine that Norway would have had to stop building oil platforms etc. half way through the process) – Wouldn´t this be a tragedy? But again, this is only speculation!

    To the causality on “sudden stops”: A “sudden stop” requires an abrupt reversal of investors willingness to finance a deficit. Take for example the crash of a large US investmentbank and a following financial crisis. This could indeed cause private investors to reevaluate the risks in your portfolio and to withdraw capital from “high risk” – countries, i.e. countries with high foreign debts and high current account deficits. This is the causality behind the “sudden stops”. To be clear, I DO NOT want to present the Lehman-Crash as the cause of the “sudden stops” that the periphery countries experienced!!!!!!! This is not proven in any contribution as far as I know.

    Finally, I want to add a remark that I should have maybe added already in my previous post. What I presented was the rebalancing-argument, i.e. rebalancing as one of the causes of the recession, which I personally regard as well founded. I argued that capital inflows stopped which brought about a current account reversal and a compression of demand as well as a recession. Basically, causality could also work in the opposite direction. A recession reduced imports which reversed the current account and therefore also capital inflows, i.e. current account rebalancing as the consequence, not the cause of the crisis. Indeed, lots of research is needed on this subject!

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