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Adjusting to the Euro

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  • Gabriel Fagan
  • Vítor Gaspar

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.

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Bibliographic Info

Paper provided by Banco de Portugal, Economics and Research Department in its series Working Papers with number w200703.

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Date of creation: 2007
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Handle: RePEc:ptu:wpaper:w200703

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  1. 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.
  2. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
  3. Christopher D. Carroll & Jody Overland & David N. Weil, 1995. "Saving and growth with habit formation," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 95-42, Board of Governors of the Federal Reserve System (U.S.).
  4. Favero, Carlo A. & Giavazzi, Francesco & Iacone, Fabrizio & Guido Tabellini, 2000. "Extracting information from asset prices: The methodology of EMU calculators," European Economic Review, Elsevier, vol. 44(9), pages 1607-1632, October.
  5. Lawrence J. Christiano & Martin Eichenbaum & Charles Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper 0107, Federal Reserve Bank of Cleveland.
  6. Mongelli, Francesco Paolo & Vega, Juan Luis, 2006. "What effects is EMU having on the euro area and its member countries? An overview," Working Paper Series, European Central Bank 0599, European Central Bank.
  7. Neary, J Peter, 1987. "Determinants of the Equilibrium Real Exchange Rate," CEPR Discussion Papers 209, C.E.P.R. Discussion Papers.
  8. Maurice Obstfeld & Kenneth Rogoff & Richard Clarida, . "The Unsustainable US Current Account Position Revisited," Working Paper 14901, Harvard University OpenScholar.
  9. John Y. Campbell & John H. Cochrane, 1995. "By Force of Habit: A Consumption-Based Explanation of Aggregate Stock Market Behavior," NBER Working Papers 4995, National Bureau of Economic Research, Inc.
  10. Obstfeld, Maurice, 1992. "International Adjustment with Habit-Forming Consumption: A Diagrammatic Exposition," Review of International Economics, Wiley Blackwell, vol. 1(1), pages 32-48, November.
  11. Velculescu Delia, 2004. "Intergenerational Habits, Fiscal Policy, and Welfare," The B.E. Journal of Macroeconomics, De Gruyter, De Gruyter, vol. 4(1), pages 1-34, September.
  12. Olivier J. Blanchard, 1984. "Debt, Deficits and Finite Horizons," NBER Working Papers 1389, National Bureau of Economic Research, Inc.
  13. Berben, Robert-Paul & Locarno, Alberto & Morgan, Julian & Vallés, Javier, 2004. "Cross-country differences in monetary policy transmission," Working Paper Series, European Central Bank 0400, European Central Bank.
  14. Lane, Philip R., 2006. "The Real Effects of EMU," CEPR Discussion Papers 5536, C.E.P.R. Discussion Papers.
  15. Gruber, Joseph W., 2004. "A present value test of habits and the current account," Journal of Monetary Economics, Elsevier, Elsevier, vol. 51(7), pages 1495-1507, October.
  16. David S. Bates, 1999. "Financial Markets' Assessment of EMU," NBER Working Papers 6874, National Bureau of Economic Research, Inc.
  17. 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.
  18. Frank Smets & Raf Wouters, 2002. "An estimated dynamic stochastic general equilibrium model of the euro area," Working Paper Research, National Bank of Belgium 35, National Bank of Belgium.
  19. 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.
  20. 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, University of Chicago Press, vol. 107(2), pages 205-251, April.
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Citations

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Cited by:
  1. Philip Lane, 2011. "The Irish Crisis," The Institute for International Integration Studies Discussion Paper Series iiisdp356, IIIS.
  2. Philip R. Lane, 2008. "EMU and Financial Market Integration," The Institute for International Integration Studies Discussion Paper Series iiisdp248, IIIS.
  3. 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.
  4. 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.
  5. 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.
  6. 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, Asociación Española de Economía y Finanzas Internacionales 10-09, Asociación Española de Economía y Finanzas Internacionales.
  7. 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, October.
  8. Philip R. Lane, 2008. "EMU and Financial Integration," The Institute for International Integration Studies Discussion Paper Series iiisdp272, IIIS.
  9. Olivier Blanchard, 2007. "Adjustment within the euro. The difficult case of Portugal," Portuguese Economic Journal, Springer, Springer, vol. 6(1), pages 1-21, April.
  10. 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, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission 293, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  11. 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, Duncker & Humblot, Berlin, vol. 55(4), pages 295-312.
  12. Alexandre Janiak, 2008. "Mobility in Europe - Why it is low, the bottlenecks, and the policy solutions," European Economy - Economic Papers, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission 340, Directorate General Economic and Monetary Affairs (DG ECFIN), European Commission.
  13. 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.
  14. 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.
  15. Marques, Luis B, 2007. "The Costs to Consumers of a Depreciated Conversion Rate to the Euro," MPRA Paper 5723, University Library of Munich, Germany.

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