The Elephant in the Euro Room

Over the medium term, the elephant in the euro area room is Germany’s record current account surplus, the direct result of the asymmetric policy response to the crisis. This reflects too weak domestic demand in Germany and results in low euro area inflation. No long-term equilibrium can be reached without that being significantly reduced. Correcting this incredibly large imbalance will be very difficult and creates future global vulnerabilities. There are only two ways: First, via real exchange rate appreciation — primarily higher inflation in Germany. This trend should be compounded by record divergence in labor markets between Germany and the euro area. Second, via losses in accumulated assets — those are now mostly outside the euro area periphery. Any future global recession will be robustly transmitted via Germany.