A very interesting guest post by Christoph Zwick following up on our discussion on Eurozone rebalancing.
Current account imbalances within the Euro-Zone are frequently regarded as one of the driving factors that contribute to the ongoing economic crisis in the periphery countries. There is, however, some often observed inaccuracy in the debate about the channel through which the imbalances affect economic growth and employment. I first want to give a more detailed view on how the mechanism works before outlining some challenges that current account rebalancing poses on the Euro-Zone.
From basic economic theory, current account imbalances reflect different saving patterns across countries. In an open economy framework, a country with ample savings can lend to foreigners in the present and increase its future spending while a country with tight savings can borrow from abroad to finance higher current consumption or investment. This “intertemporal trade” is commonly regarded as welfare enhancing. Take for example Norway in the 1970s. The country borrowed extensively from abroad to develop its North Sea oil resources after world oil prices shot up. The result was a large current account deficit for four consecutive years that peaked at close to -14% of GDP in 1978, a value which even exceeds the deficits of the Euro-Zone-periphery before 2008. Soon after, the Norwegian current account returned to positive values, all debts were repaid and the development of the North Sea oil resources is still regarded as a success story.
In contrast to these considerations, current account imbalances are thought to have substantially contributed, if not triggered, the crisis in Latin America in the 1980s, the Asian crisis in the late 1990s and nowadays the crisis in the Euro-Zone periphery countries. So what is wrong with imbalances? The answer is that we should not care about the imbalances itself, but about the contraction of current account deficits. More on that below the fold.