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The importance of trade and capital imbalances in the European debt crisis

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  • Hughes Hallett, Andrew
  • Martinez Oliva, Juan Carlos

Abstract

The European crisis has highlighted the role of intra-European payments imbalances for the survival of the EMU. Payment imbalances between the North and the South have contributed to the accumulation of large stock of foreign debt, while flows of foreign capital ceased to finance productive investments which might have contributed to debt repayments—preferring instead to finance consumption and a housing bubble. The dynamic interplay between current account imbalances and the accumulation of debt reveals that, once the system is driven into disequilibrium by a real exchange rate misalignment, the longer a payments imbalance persists the harder the eventual adjustment will be. Capital reversals, by shifting portfolio balances, lead the system toward instability, sovereign default, and the collapse of the exchange rate regime. Replacing private with public creditors may temporarily help us to stay away from the point where the system breaks down. But this is only a temporary expedient because the underlying imbalances need continued and escalating financing until equilibrium is restored by other means. One permanent solution is the ECB's official monetary transactions program, if the potential expansions to the central bank's balance sheet can be tolerated.

Suggested Citation

  • Hughes Hallett, Andrew & Martinez Oliva, Juan Carlos, 2015. "The importance of trade and capital imbalances in the European debt crisis," Journal of Policy Modeling, Elsevier, vol. 37(2), pages 229-252.
  • Handle: RePEc:eee:jpolmo:v:37:y:2015:i:2:p:229-252
    DOI: 10.1016/j.jpolmod.2015.02.001
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    References listed on IDEAS

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    Cited by:

    1. Kozlova, Olesia & de Jesus Noguera, Jose, 2018. "Achievers or slackers? Per capita income trends in European countries," Journal of Policy Modeling, Elsevier, vol. 40(6), pages 1332-1345.
    2. Siddique, Abu & Selvanathan, E.A. & Selvanathan, Saroja, 2016. "The impact of external debt on growth: Evidence from highly indebted poor countries," Journal of Policy Modeling, Elsevier, vol. 38(5), pages 874-894.
    3. Juan Carlos Martinez Oliva, 2014. "Moving Towards Monetary Integration in East Asia: Achieving Economic Convergence in a Game-Theory Framework," China Economic Policy Review (CEPR), World Scientific Publishing Co. Pte. Ltd., vol. 3(02), pages 1-24.
    4. Ekici, Oya & Nemlioğlu, Karun, 2017. "Emerging economies’ short-term private external debt as evidence of economic crisis," Journal of Policy Modeling, Elsevier, vol. 39(2), pages 232-246.
    5. Walter Paternesi Meloni, 2017. "Austerity & Competitiveness in the Eurozone: a misleading linkage," Departmental Working Papers of Economics - University 'Roma Tre' 0223, Department of Economics - University Roma Tre.

    More about this item

    Keywords

    External debt; Trade space; Real exchange rate adjustments; Official financing; OMT;

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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