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Real exchange rates and current account imbalances in the Euro-area


  • Michael G Arghyrou

    (Cardiff Business School)

  • Georgios Chortareas

    (University of Essex)


Global current account imbalances have been one of the focal points of interest for policymakers during the last few years. Less attention has been paid, however, to the growing imbalances within the Euro-area. In the short period since the commencement of the EMU two distinct groups of member state have emerged: those with consistently improving current accounts and those with consistently worsening current accounts. In this paper we consider the dynamics of current account adjustment and the role of real exchange rates in current account determination in the EMU member countries. Monetary union participation, which entails giving up the nominal exchange rate, can make the correction of current account imbalances more cumbersome. While most theoretical models of open economies rely on a causal relationship between real exchange rates and the current account limited, if any, contemporary evidence exist on the empirical validity of this relationship. We find that the above relationship is substantial in size and subject to pronounced non-linear effects. We identify two groups of countries since the abandonment of European national currencies: those with persistent real exchange rate depreciation leading to current account improvement; and those with systematic real appreciation and deteriorating current accounts. These groups largely correspond to those previous research has identified as respectively belonging and not belonging to a European Optimum Currency Area. Our findings validate the theoretical arguments concerning the potential costs of EMU participation and suggest that meeting the nominal convergence criteria has come, in some countries, at the cost of growing current account imbalances. The latter pose policy-response questions for national authorities and the ECB, suggesting that it may be optimal to add to the EMU-accession criteria one referring to the balance of the current account; and highlighting the importance of increasing the flexibility of relative prices to facilitate real exchange rate and current account adjustment

Suggested Citation

  • Michael G Arghyrou & Georgios Chortareas, 2007. "Real exchange rates and current account imbalances in the Euro-area," Money Macro and Finance (MMF) Research Group Conference 2006 124, Money Macro and Finance Research Group.
  • Handle: RePEc:mmf:mmfc06:124

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    References listed on IDEAS

    1. Maurice Obstfeld & Kenneth Rogoff, 2007. "The Unsustainable U.S. Current Account Position Revisited," NBER Chapters,in: G7 Current Account Imbalances: Sustainability and Adjustment, pages 339-376 National Bureau of Economic Research, Inc.
    2. Glick, Reuven & Rogoff, Kenneth, 1995. "Global versus country-specific productivity shocks and the current account," Journal of Monetary Economics, Elsevier, vol. 35(1), pages 159-192, February.
    3. Maurice Obstfeld & Kenneth S. Rogoff, 2005. "Global Current Account Imbalances and Exchange Rate Adjustments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(1), pages 67-146.
    4. Obstfeld, Maurice & Rogoff, Kenneth, 1995. "Exchange Rate Dynamics Redux," Journal of Political Economy, University of Chicago Press, vol. 103(3), pages 624-660, June.
    5. Olivier Blanchard & Francesco Giavazzi, 2002. "Current Account Deficits in the Euro Area: The End of the Feldstein Horioka Puzzle?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 33(2), pages 147-210.
    6. Inder, Brett, 1993. "Estimating long-run relationships in economics : A comparison of different approaches," Journal of Econometrics, Elsevier, vol. 57(1-3), pages 53-68.
    7. Arghyrou, Michael G. & Luintel, Kul B., 2007. "Government solvency: Revisiting some EMU countries," Journal of Macroeconomics, Elsevier, vol. 29(2), pages 387-410, June.
    8. Quintos, Carmela E, 1995. "Sustainability of the Deficit Process with Structural Shifts," Journal of Business & Economic Statistics, American Statistical Association, vol. 13(4), pages 409-417, October.
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    Cited by:

    1. Belke, Ansgar & Dreger, Christian, 2011. "Current account imbalances in the euro area: Catching up or competitiveness?," Discussion Papers 297, European University Viadrina Frankfurt (Oder), Department of Business Administration and Economics.

    More about this item


    current account; real exchange rate; EMU; nonlinearities;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • 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

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