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The costs of rebalancing the Euro area

  • Engelbert Stockhammer

    ()

    (Kingston University)

  • Dimitris P. Sotiropoulos

    (Kingston University)

This paper investigates the economic costs of Euro area rebalancing. 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 eleven Euro area members (excluding Luxembourg). 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, it would necessitate a reduction of GPD by some 47%. These are staggering amounts and, indeed we think that such a reduction of GDP should not be imposed in the GIIPS group. Moreover, we doubt whether it would be politically feasible. In principle there are two ways that trade imbalances could be resolved: deflationary adjustment in the deficit countries or inflationary adjustment in the surplus countries. Presently, the burden of adjustment is exclusively on the deficit countries. Our results indicate that the economic costs of this 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.

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File URL: http://www.postkeynesian.net/downloads/wpaper/PKWP1206.pdf
File Function: First version, 2012
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Paper provided by Post Keynesian Economics Study Group (PKSG) in its series Working Papers with number PKWP1206.

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Length: 38 pages
Date of creation: Jun 2012
Date of revision:
Handle: RePEc:pke:wpaper:pkwp1206
Contact details of provider: Web page: http://www.postkeynesian.net

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  1. Belke, Ansgar & Dreger, Christian, 2011. "Current account imbalances in the euro area: Catching up or competitiveness?," Annual Conference 2011 (Frankfurt, Main): The Order of the World Economy - Lessons from the Crisis 48711, Verein für Socialpolitik / German Economic Association.
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  17. Hein, Eckhard & Truger, Achim, 2005. "European Monetary Union: nominal convergence, real divergence and slow growth?," Structural Change and Economic Dynamics, Elsevier, vol. 16(1), pages 7-33, March.
  18. 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.
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  22. Edward S. Knotek & II, 2007. "How useful is Okun's law?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 73-103.
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