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Adjusting to the euro

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Author Info
Gabriel Fagan () (European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany.)
Vítor Gaspar () (Banco de Portugal, Avenida Almirante Reis, 71-8o, 1150, Lisboa, Portugal.)

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Abstract

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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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
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Handle: RePEc:ecb:ecbwps:20070716

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Related research
Keywords: Euro area interest rate convergence overlapping generations model.

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This paper has been announced in the following NEP Reports: References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. 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. [Downloadable!]
  2. David S. Bates, 1999. "Financial Markets' Assessment of EMU," NBER Working Papers 6874, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Blanchard, Olivier J, 1985. "Debt, Deficits, and Finite Horizons," Journal of Political Economy, University of Chicago Press, vol. 93(2), pages 223-47, April. [Downloadable!] (restricted)
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  4. Christopher D. Carroll & Jody Overland & David N. Weil, 2000. "Saving and Growth with Habit Formation," American Economic Review, American Economic Association, vol. 90(3), pages 341-355, June. [Downloadable!] (restricted)
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  5. Maurice Obstfeld & Kenneth Rogoff, 2004. "The Unsustainable US Current Account Position Revisited," NBER Working Papers 10869, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Abel, A.B., 1990. "Asset Prices Under Habit Formation And Catching Up With The Joneses," Weiss Center Working Papers 1-90, Wharton School - Weiss Center for International Financial Research.
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  7. 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(2002-2), pages 147-210. [Downloadable!]
  8. Obstfeld, Maurice, 1992. "International Adjustment with Habit-Forming Consumption: A Diagrammatic Exposition," Review of International Economics, Blackwell Publishing, vol. 1(1), pages 32-48, November.
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  9. Philip R. Lane, 2006. "The Real Effects of EMU," The Institute for International Integration Studies Discussion Paper Series iiisdp115, IIIS. [Downloadable!]
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  10. John Y. Campbell & John Cochrane, 1999. "Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," Journal of Political Economy, University of Chicago Press, vol. 107(2), pages 205-251, April. [Downloadable!] (restricted)
  11. Nicholai Benalal & Juan Luis Diaz del Hoyo & Beatrice Pierluigi & Nikiforos Vidalis, 2006. "Output growth differentials across the euro area countries - some stylised facts," Occasional Paper Series 45, European Central Bank. [Downloadable!]
  12. Robert-Paul Berben & Alberto Locarno & Julian Morgan & Javier Valles, 2004. "Cross-country differences in monetary policy transmission," Working Paper Series 400, European Central Bank. [Downloadable!]
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  13. 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. [Downloadable!] (restricted)
  14. 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. [Downloadable!] (restricted)
  15. Lawrence J. Christiano, Martin Eichenbaum, and Charles L. Evans, 2005. "Nominal Rigidities and the Dynamic Effects of a Shock to Monetary Policy," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 1-45, February.
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Philip R. Lane, 2008. "EMU and Financial Market Integration," The Institute for International Integration Studies Discussion Paper Series iiisdp248, IIIS. [Downloadable!]
  2. Matteo Ciccarelli & Carlo Altavilla, 2007. "Inflation forecasts, monetary policy and unemployment dynamics: evidence from the US and the euro area," Working Paper Series 725, European Central Bank. [Downloadable!]
    Other versions:
  3. Dieter Gerdesmeier & Francesco Paolo Mongelli & Barbara Roffia, 2007. "The Eurosystem, the US Federal Reserve and the Bank of Japan - similarities and differences," Working Paper Series 742, European Central Bank. [Downloadable!]
    Other versions:
  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. [Downloadable!]
  5. Michele Ca’ Zorzi & Michal Rubaszek, 2008. "On the empirical evidence of the intertemporal current account model for the euro area countries," Working Paper Series 895, European Central Bank. [Downloadable!]
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