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External Imbalances, Gross Capital Flows and Sovereign Debt Crises

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  • Sergio de Ferra

    (Stockholm University)

Abstract

The experience of the European monetary union has been characterized by three distinctive facts. First, core and periphery countries ran widening current account surplus and deficit positions, after the inception of the union. Second, core countries intermediated gross capital flows from the rest of the world, which in turn financed deficits in the periphery. Finally, a sovereign debt crisis took place, affecting multiple countries and causing severe recessions. I argue that institutional features of the European Economic and Monetary Union are responsible for the observation of imbalances, intermediation and pervasive crises. First, I show in a theoretical model that subsidies on holdings of euro-denominated assets contribute to all three phenomena. Second, I build a dynamic model of an economic union with trade in goods and financial assets. In the model, the introduction of a subsidy on cross-border asset holdings generates predictions for net and gross asset flows that quantitatively replicate the euro area experience. The model features a novel theoretical mechanism magnifying the severity of a debt crisis in an economic union, due to the joint presence of financial and trade linkages among union members. This mechanism is likely to have exacerbated the recent recession in the euro area periphery.

Suggested Citation

  • Sergio de Ferra, 2017. "External Imbalances, Gross Capital Flows and Sovereign Debt Crises," 2017 Meeting Papers 726, Society for Economic Dynamics.
  • Handle: RePEc:red:sed017:726
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    References listed on IDEAS

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    Cited by:

    1. Sergio De Ferra & Enrico Mallucci, 2020. "Avoiding Sovereign Default Contagion: A Normative Analysis," FEDS Notes 2020-09-21, Board of Governors of the Federal Reserve System (U.S.).
    2. Daniele Siena, 2021. "The Euro Area Periphery and Imbalances: Is it an Anticipation Story?," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 40, pages 278-308, April.
    3. de Ferra, Sergio & Romei, Federica, 2018. "Sovereign Default in a Monetary Union," CEPR Discussion Papers 12976, C.E.P.R. Discussion Papers.
    4. Ivan Jaccard & Frank Smets, 2020. "Structural Asymmetries and Financial Imbalances in the Eurozone," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 36, pages 73-102, April.
    5. Kobielarz, Michal, 2018. "The economics of monetary unions," Other publications TiSEM b0293536-68ec-4905-bffd-6, Tilburg University, School of Economics and Management.

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