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Adjusting to the euro

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In this paper we argue that, for a group of converging economies of the European Union, participation in the euro area has been associated with easier access to financing by domestic economic agents. Easier access to financing was a significant impulse leading to a sharp increase in households' expenditures and a corresponding fall in the savings ratio. Increased expenditure was associated with current account deficits, a sharp fall in the net foreign asset position and an increase in the households' indebtedness. At the same time there was a sizeable increase in the real exchange rate. In this paper, we show that it is possible to obtain all these qualitative features of adjustment using a simple analytical model of intertemporal equilibrium. Specifically, we consider a simple endowment economy with traded and non-traded goods populated by Blanchard-Yaari households. We also argue that the consideration of external habit formation improves the model's ability to mimic short to medium term adjustment dynamics while, at the same time, improving the plausibility of steady state effects. JEL Classification: F36, E21, F32.

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 716.

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Length: 42 pages
Date of creation: Jan 2007
Date of revision:
Handle: RePEc:ecb:ecbwps:20070716

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Keywords: Euro area; interest rate convergence; overlapping generations model.;

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  1. Jody Overland & Christopher D. Carroll & David N. Weil, 2000. "Saving and Growth with Habit Formation," American Economic Review, American Economic Association, vol. 90(3), pages 341-355, June.
  2. Maurice Obstfeld & Kenneth Rogoff, 2004. "The Unsustainable US Current Account Position Revisited," NBER Working Papers 10869, National Bureau of Economic Research, Inc.
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  6. Robert-Paul Berben & Alberto Locarno & Julian Morgan & Javier Valles, 2004. "Cross-country differences in monetary policy transmission," Working Paper Series 400, European Central Bank.
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  8. Mansoorian, Arman, 1993. "Habit persistence and the Harberger-Laursen-Metzler effect in an infinite horizon model," Journal of International Economics, Elsevier, vol. 34(1-2), pages 153-166, February.
  9. Gruber, Joseph W., 2004. "A present value test of habits and the current account," Journal of Monetary Economics, Elsevier, vol. 51(7), pages 1495-1507, October.
  10. Delia Velculescu, 2004. "Intergenerational Habits, Fiscal Policy, and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, vol. 0(1), pages 10.
  11. John Y. Campbell & John H. Cochrane, 1994. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," CRSP working papers 412, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  12. Francesco Paolo Mongelli & Juan Luis Vega, 2006. "What effects is EMU having on the euro area and its member countries? An overview," Working Paper Series 599, European Central Bank.
  13. David S. Bates, 1999. "Financial Markets' Assessment of EMU," NBER Working Papers 6874, National Bureau of Economic Research, Inc.
  14. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April.
  15. Olivier Blanchard & Francesco Giavazzi, 2002. "Current Account Deficits in the Euro Area: The End of the Feldstein Horioka Puzzle?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 147-210.
  16. Maurice Obstfeld, 1993. "International Adjustment with Habit-Forming Consumption: A Diagrammatic Exposition," NBER Working Papers 4094, National Bureau of Economic Research, Inc.
  17. Frank Smets & Raf Wouters, 2003. "An Estimated Dynamic Stochastic General Equilibrium Model of the Euro Area," Journal of the European Economic Association, MIT Press, vol. 1(5), pages 1123-1175, 09.
  18. Philip R. Lane, 2006. "The Real Effects of EMU," The Institute for International Integration Studies Discussion Paper Series iiisdp115, IIIS.
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Citations

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Cited by:
  1. Lane, Philip R., 2011. "The Irish Crisis," CEPR Discussion Papers 8287, C.E.P.R. Discussion Papers.
  2. Philip R. Lane, 2008. "EMU and Financial Market Integration," The Institute for International Integration Studies Discussion Paper Series iiisdp248, IIIS.
  3. Andrzej Torój, 2010. "Adjustment capacity in a monetary union: a DSGE evaluation of Poland and Slovakia," Working Papers 3, Ministry of Finance in Poland.
  4. Marques, Luis B, 2007. "The Costs to Consumers of a Depreciated Conversion Rate to the Euro," MPRA Paper 5723, University Library of Munich, Germany.
  5. Philip R. Lane, 2008. "EMU and Financial Integration," The Institute for International Integration Studies Discussion Paper Series iiisdp272, IIIS.
  6. Fernando Alexandre & Pedro Bação & João Cerejeira & Miguel Portela, 2010. "Manufacturing employment and exchange rates in the Portuguese economy: the role of openness, technology and labour market rigidity," GEMF Working Papers 2010-23, GEMF - Faculdade de Economia, Universidade de Coimbra.
  7. Mariam Camarero & Josep Lluís Carrion-i-Silvestre & Cecilio Tamarit, 2010. "External imbalances in a monetary union. Does the Lawson doctrine apply to Europe?," Working Papers 1006, Department of Applied Economics II, Universidad de Valencia.
  8. Barry Eichengreen & Katharina Steiner, 2008. "Is Poland at Risk of a Boom-and-Bust Cycle in the Run-Up to Euro Adoption?," NBER Working Papers 14438, National Bureau of Economic Research, Inc.
  9. Sabine Herrmann, 2009. "Do We Really Know That Flexible Exchange Rates Facilitate Current Account Adjustment? Some New Empirical Evidence for CEE Countries," Applied Economics Quarterly (formerly: Konjunkturpolitik), Duncker & Humblot, Berlin, vol. 55(4), pages 295-312.
  10. Pradeep Mitra & Marcelo Selowsky & Juan Zalduendo, 2010. "Turmoil at Twenty : Recession, Recovery, and Reform in Central and Eastern Europe and the Former Soviet Union," World Bank Publications, The World Bank, number 2682.
  11. Holger Zemanek & Ansgar Belke & Gunther Schnabl, 2010. "Current account balances and structural adjustment in the euro area," International Economics and Economic Policy, Springer, vol. 7(1), pages 83-127, May.
  12. Olivier Blanchard, 2007. "Adjustment within the euro. The difficult case of Portugal," Portuguese Economic Journal, Springer, vol. 6(1), pages 1-21, April.
  13. Cristian Stefan Ovidiu, 2011. "The Risks Of A Too Quick Euro Adoption By The Eu Member States. The Case Of Portugal," Annals of Faculty of Economics, University of Oradea, Faculty of Economics, vol. 1(2), pages 25-32, December.
  14. Pedro Bação & António Portugal Duarte, 2010. "Accession to the European Union, Interest Rates and Indebtedness: Greece and Portugal," GEMF Working Papers 2011-04, GEMF - Faculdade de Economia, Universidade de Coimbra.
  15. Alexandre Janiak, 2008. "Mobility in Europe - Why it is low, the bottlenecks, and the policy solutions," European Economy - Economic Papers 340, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  16. C. Martinez-Mongay & L.A. Maza Lasierra & J. Yaniz Igal, 2007. "Asset Booms and Tax Receipts: The case of Spain, 1995-2006," European Economy - Economic Papers 293, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.

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