The Euro Plus Pact. Competitiveness and external capital flows in the EU countries

The Euro Plus Pact was approved by 23 EU countries in March 2011. The Pact stipulates a range of quantitative targets meant to strengthen competitiveness and convergence with the ultimate aim of preventing the accumulation of unsustainable financial imbalances. This paper uses Granger causality tests and vector autoregressive models to assess the short-term linkages between changes in the relative unit labour cost and changes in the current account balance. The sample consists of data for 27 EU countries for the period 1995?2012. The main finding is that changes in the current account balance precedes changes in relative unit labour costs, while there is no discernable effect in the opposite direction. This suggests that the divergence in the unit labour cost between the countries in Northern Europe and countries in Southern and Central and Eastern Europe prior to the global financial crisis partly was the result of capital flows from the core of Europe to its periphery. The results also suggest that measures in the Euro Plus Pact to restrain unit labour costs may not have immediate effects on possible current account imbalances.