The European Monetary Union and Imbalances: Is it an Anticipation Story ?

This paper investigates the sources of current account imbalances accumulated within the European Monetary Union before the Great Recession. First, it documents that starting in 1996, before the actual introduction of the euro, countries in the euro area periphery experienced increasing current account deficits, appreciating real exchange rates and output growing faster than trends. Then, it develops and estimates a small open economy DSGE model which encompasses a variety of possible unanticipated and anticipated shocks. The main finding is that anticipated reductions in international borrowing costs can explain the observed evidence while productivity increases (anticipated or not) cannot: falling borrowing costs implies appreciation while increasing productivity implies depreciation. Quantitatively, anticipated shocks account for one third of output, half of real exchange rate and two third of current account fluctuations. In particular, anticipated fluctuations in international borrowing costs explain respectively 30 and 40 percent of current account and real exchange rate movements.