Are Current Account Imbalances Between EMU Countries Sustainable? Evidence from Parametric and Non-Parametric Tests

Using parametric and non-parametric estimation techniques, we analyze the sustainability of the recently growing current account imbalances in the Euro Area and test whether the introduction of the European Monetary Union has aggravated these imbalances. For these purposes two alternative criteria for the assessment of external debt sustainability are considered: One based on intertemporal budget constraints as proposed by Bohn (1998), and the other based on the stationarity properties of the stochastic process of the debt-to-GDP ratio. The Bohn test is applied using the pooled mean-group estimator proposed by Pesaran and Smith (1995). Mean reversion is analyzed by the Breitung panel unit root test. Variants of both test procedures with time varying coercients using penalized splines estimation are performed. We find empirical evidence suggesting that the introduction of the EMU is associated with a regime shift from sustainability to unsustainability of external debt accumulation among the Euro countries considered.