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Rebalancing the Euro Area: The Costs of Internal Devaluation

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  • Engelbert Stockhammer
  • Dimitris P. Sotiropoulos

Abstract

This paper investigates the economic costs of rebalancing current account positions in the Euro area by means of internal devaluation. Internal devaluation relies on wage suppression in the deficit countries. Based on an old Keynesian model we estimate a current account equation, a wage-Phillips curve and an Okun's Law equation. All estimations are carried out for a panel of twelve Euro area members. From the estimation results we calculate the output costs of reducing current account deficits. Greece, Ireland, Italy, Portugal and Spain (GIIPS) had, on average, current account deficits of 8.4% of GDP in 2007. To eliminate these current account deficits, a reduction of GPD by some 47% would be necessary. Trade imbalances can be resolved in two ways: deflationary adjustment in the deficit countries or inflationary adjustment in the surplus countries. The economic costs of deflationary adjustment to those countries are equivalent to the output loss of the Great Depression. An adjustment of the surplus countries would increase growth and it would come with higher inflation, but it would allow rebalancing without a Great Depression in parts of Europe.

Suggested Citation

  • Engelbert Stockhammer & Dimitris P. Sotiropoulos, 2014. "Rebalancing the Euro Area: The Costs of Internal Devaluation," Review of Political Economy, Taylor & Francis Journals, vol. 26(2), pages 210-233, April.
  • Handle: RePEc:taf:revpoe:v:26:y:2014:i:2:p:210-233
    DOI: 10.1080/09538259.2014.881011
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    Cited by:

    1. Claudius Gräbner & Philipp Heimberger & Jakob Kapeller & Bernhard Schütz, 2017. "Is Europe disintegrating? Macroeconomic divergence, structural polarization, trade and fragility," Economics working papers 2017-15, Department of Economics, Johannes Kepler University Linz, Austria.
    2. Philipp Heimberger & Jakob Kapeller, 2017. "The performativity of potential output: pro-cyclicality and path dependency in coordinating European fiscal policies," Review of International Political Economy, Taylor & Francis Journals, vol. 24(5), pages 904-928, September.
    3. Engelbert Stockhammer & Cédric Durand & Ludwig List, 2015. "European growth models and working class restructuring before the crisis," Working Papers PKWP1508, Post Keynesian Economics Society (PKES).
    4. Michaelis Nikiforos & Laura Carvalho & Christian Schoder, 2014. ""Twin deficits" in Greece in search of causality," IMK Working Paper 143-2014, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    5. Stockhammer, Engelbert & Durand, Cédric & List, Ludwig, 2015. "Growth models and working class restructuring before the crisis," Economics Discussion Papers 2015-4, School of Economics, Kingston University London.
    6. Alexander Guschanski & Engelbert Stockhammer, 2017. "Are current accounts driven by competitiveness or asset prices? A synthetic model and an empirical test," Working Papers PKWP1716, Post Keynesian Economics Society (PKES).
    7. Eckhard Hein & Eckhard Achim Truger, 2017. "Opportunities and limits of rebalancing the Eurozone via wage policies," FMM Working Paper 06-2017, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    8. Hatgioannides, John & Karanassou, Marika & Sala, Hector & Karanasos, Menelaos G. & Koutroumpis, Panagiotis, 2017. "The legacy of a fractured Eurozone: the Greek Dra(ch)ma," LSE Research Online Documents on Economics 84542, London School of Economics and Political Science, LSE Library.

    More about this item

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian
    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • F40 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - General

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