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Optimal adjustment paths in a monetary union

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  • Belke, Ansgar
  • Gros, Daniel

Abstract

What to do when a country experiences a sudden stop in capital inflows and has to adjust externally? Sticky wages make adjustment to an external imbalance more difficult within a monetary union. Periods of high unemployment are usually necessary to achieve the required real depreciation (internal devaluation). Gradual adjustment is usually recommended to distribute the output and employment cost over time. But a gradual adjustment also implies that current account deficits persist for longer, leading to higher debt, and higher debt-service costs. The optimal path of price and wage adjustment thus involves a trade-off between the pain (unemployment) and the gain (lower debt) from adjustment. A simple model shows the determinants of the optimal path in terms of deeper parameters, such as the slope of the Phillips curve and the degree of openness. The rules for the resolution of future crises within the euro area should take this into account. Gradual adjustment is not always the optimal choice, and sometimes the alternative path of introducing abrupt changes produces the desired results.

Suggested Citation

  • Belke, Ansgar & Gros, Daniel, 2017. "Optimal adjustment paths in a monetary union," Economic Modelling, Elsevier, vol. 67(C), pages 338-345.
    • Handle: RePEc:eee:ecmode:v:67:y:2017:i:c:p:338-345
    DOI: 10.1016/j.econmod.2017.02.011
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    Cited by:

    1. Milone, Luciano Marcello, 2020. "Structural Reforms in the European Union: What is New after the Crisis?," Economia Internazionale / International Economics, Camera di Commercio Industria Artigianato Agricoltura di Genova, vol. 73(3), pages 351-372.
    2. Belke Ansgar, 2018. "Secular Stagnation, Unemployment Hysteresis and Monetary Policy in EMU: Scratches but Not Scars?," The Economists' Voice, De Gruyter, vol. 15(1), pages 1-14, December.
    3. Ansgar Belke & Daniel Gros, 2017. "Greece and the Troika – Lessons from International Best Practice Cases of Successful Price (and Wage) Adjustment," European Journal of Comparative Economics, Cattaneo University (LIUC), vol. 14(2), pages 177-195, December.
    4. Mitali Das, 2023. "Probabilistic assessment of external sustainability in Portugal," Portuguese Economic Journal, Springer;Instituto Superior de Economia e Gestao, vol. 22(1), pages 5-29, January.
    5. Cyrille Lenoël & Corrado Macchiarelli & Garry Young, 2023. "Greece 2010–18: What Could Have Been Done Differently?," Open Economies Review, Springer, vol. 34(2), pages 281-315, April.
    6. Fabian Lindner, 2018. "Changes of the price level and the nominal exchange rate can have quite different impacts on the trade balance," IMK Working Paper 191-2018, IMK at the Hans Boeckler Foundation, Macroeconomic Policy Institute.
    7. Navarro-Ortiz, Josep & Sapena, Juan, 2020. "Is external debt sustainable? A probabilistic approach," Economic Modelling, Elsevier, vol. 93(C), pages 142-153.
    8. Dinabandhu Sethi & Debashis Acharya, 2018. "Estimating Sectoral Disinflation Cost in India: Some Structural VAR Evidence," Journal of Quantitative Economics, Springer;The Indian Econometric Society (TIES), vol. 16(1), pages 23-46, December.

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    More about this item

    Keywords

    F41; F45; P11; Speed of adjustment; Openness; Phillips curve; Price and wage adjustment; Internal devaluation; Policy complementarities;
    All these keywords.

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions
    • P11 - Political Economy and Comparative Economic Systems - - Capitalist Economies - - - Planning, Coordination, and Reform

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