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Country adjustment to a ‘sudden stop’: Does the euro make a difference?

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Author Info

  • Daniel Gros
  • Cinzia Alcidi

Abstract

A ‘sudden stop’ to (private) capital inflows is usually very disruptive to an economy because it forces an almost immediate reversal in the current account unless the country in question receives substantial balance of payments assistance. The analysis presented in this paper starts from the observation that two groups of European countries, neither of which could use the exchange rate as an adjustment instrument, experienced a sudden stop after the outbreak of the global financial crisis. The first group comprises five euro area member states under financial stress during the euro area debt crisis (“GIIPS”). The second group comprises four newer EU Member States in Central and Eastern Europe (“BELL”). We highlight the differences in the adjustment paths of these two groups and analyse the factors which can explain them. The main finding is that the adjustment was quicker outside EMU than inside. The shock absorbers provided by the financial ‘plumbing’ of the Eurosystem offset much of the reversal in private capital flows and seem to have created an environment in which the pressure for a quick adjustment was much weaker. We also find that the structure of the domestic banking industry plays a key role. Foreign ownership of banks provided a loss absorber in the BELL favouring a quick correction, while the legacy of the banking crisis in some of GIIPS, where foreign ownership of banks was limited, is likely to weight for long time on their still incomplete.

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Bibliographic Info

Paper provided by Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission in its series European Economy - Economic Papers with number 492.

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Length: 47 pages
Date of creation: Apr 2013
Date of revision:
Handle: RePEc:euf:ecopap:0492

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Cited by:
  1. Philip R. Lane, 2014. "International Financial Flows and the Irish Crisis," CESifo Forum, Ifo Institute for Economic Research at the University of Munich, vol. 15(2), pages 14-19, 04.
  2. Herrmann, Sabine & Jochem, Axel, 2013. "Current account adjustment in EU countries: Does euro-area membership make a difference?," Discussion Papers 49/2013, Deutsche Bundesbank, Research Centre.
  3. Philip R. Lane, 2014. "International Financial Flows and the Irish Crisis," The Institute for International Integration Studies Discussion Paper Series iiisdp444, IIIS.
  4. Eloísa Ortega & Juan Peñalosa, 2013. "Some Thoughts On The Spanish Economy After Five Years Of Crisis," Banco de Espa�a Occasional Papers 1304, Banco de Espa�a.

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