Imbalances and Adjustment

This section reviews ideas and evidence on adjustment in the EMU, including shock absorption and external imbalances. First, it presents the main issues with macroeconomic adjustment in a monetary union and the debate that surrounded the EMU project. Second, the section reviews the empirical evidence and presents key facts about the EMU performance in adjusting to asymmetric shocks. The point is made that, overall, the adjustment mechanisms worked as predicted, with competitiveness reacting in such a way as to absorb asymmetric shocks. However, contrary to expectations, the EMU start-up shock had major and long-lasting country-specific effects on income and employment. Moreover, in light of accumulated macroeconomic imbalances, the financial crisis produced major country-specific effects. Third, the section discusses adjustment issues related to external imbalances. It is argued that the accumulation of external imbalances turned out more disruptive than thought in the early EMU years, as they were followed by current account reversals and deep recessions that interrupted the convergence process.