Current account imbalances in the euro area: Does catching up explain - PowerPoint PPT Presentation

Current account imbalances in the euro area: Does catching up explain the development? 8 th European Seminar 2011 July 7 ‐ 10, 2011 ELIAMEP Poros/Greece Ansgar Belke University Duisburg ‐ Essen & DIW Berlin

Contribution of the paper • Current account on balance for the entire euro area • Imbalances striking for individual members – Exceed imbalances in the global economy – Deficits of 10 percent in peripheral countries – Divergences increased after euro introduction • Analysis of factors driving current accounts – Catching up and competition components – Panel integration and cointegration methods

Current account imbalances Note: AMECO. Current account to GDP ratio. Surplus: Germany, Netherlands. Deficit: Greece, Portugal, Spain.

Catching up component • Intertemporal approach to current account • Imbalances reflect a convergence process – Poor countries attract foreign capital due to higher growth prospects – Investment exceeds savings over catching up period, implies current account deficits – Higher permanent income perspectives raise private consumption • Higher foreign debt needs to be financed by future net exports from tradables sector

Institutional component • Monetary union facilitated allocation of investment flows – Elimination of the exchange rate risk – Access to greater pool of savings • Interest rate convergence led to large capital inflows in peripheral countries – Decrease in real interest rates lowered user costs and caused current account deficits • Cost advantages reversed due to perception of risk after the financial crisis

Competition component • Indication of excessive borrowing – Shifts to non ‐ tradables sector like construction – Overly rosy expectations for convergence – High wage increases reduced competitiveness • Real exchange rate can drive imbalances – Changes in relative prices and (labour) costs – Deficit countries lost competitiveness as domestic prices increased more than foreign prices – Real appreciation causes current account deficits

Design of empirical analysis • Panel of 11 euro area countries, 1982 ‐ 2010 • Panel integration and cointegration methods – Increase in power relative to conventional tests – Cross section correlation • Potential drivers of current account – Determinants of savings and investment – Real per capita income, real exchange rate, real interest rate, government debt ratio – Institutional factors by country fixed effects

Panel integration • Pesaran (2007) approach for the joint null of a unit root • Extension of standard ADF regression – Common components in time series – Cross section averages of lagged levels and first differences – Regressions for individual panel members – Standardized pooled t ‐ ratio for ADF coefficients – Asymptotically distributed as N(0,1)

Panel cointegration • Westerlund (2007) tests for joint null of no cointegration • Feedback parameter in conditional ECMs – ECMs estimated for individual panel members, statistics pooled in four ways – Short ‐ run dynamics and trends can be different • Panel statistics (restricted version) and group statistics – Different consequences, if null is rejected • Critical values by bootstrap methods

Unit root tests Levels First differences 1.283 -3.751 Current account (ca) (0.900) (0.000) 0.624 -3.178 Real per capita income (ypc) (0.734) (0.001) -0.131 -5.279 Real effective exchange rate (rer) (0.448) (0.000) -0.741 -6.519 Long term real interest rate (rl) (0.229) (0.000) 1.777 -2.765 Government debt ratio (debt) (0.962) (0.003)

Cointegration tests G τ G α P τ P α -2.754 -0.752 -3.882 -4.085 ca, ypc (0.005) (0.056) (0.004) (0.004) -1.873 -0.320 -3.291 -3.571 ca, rer (0.095) (0.191) (0.044) (0.055) -2.766 -0.411 -3.340 -2.698 ca, ypc, rer (0.028) (0.121) (0.026) (0.048) -1.982 0.518 -2.535 -1.284 ca, ypc, rer, rl (0.096) (0.230) (0.028) (0.094) -2.645 0.374 -3.073 -2.119 ca, ypc, rer, debt (0.050) (0.236) (0.054) (0.064) -0.168 2.024 -1.723 -0.645 ca, ypc, rer, rl, debt (0.339) (0.436) (0.066) (0.108)

Current account determinants 1982-2010 1991-2010 1982-2010 1991-2010 1982-2010 1991-2010 0.063 0.006 0.056 0.012 0.016 -0.016 ypc (0.014) (0.022) (0.014) (0.022) (0.019) (0.028) -0.164 -0.150 -0.161 -0.144 -0.168 -0.154 rer (0.014) (0.019) (0.014) (0.019) (0.014) (0.019) 0.007 0.008 rl (0.003) (0.003) -0.026 -0.016 debt (0.007) (0.012) R 2 0.714 0.770 0.733 0.777 0.724 0.771

Current account determinants (II) Surplus countries 1982-2010 1991-2010 1982-2010 1991-2010 1982-2010 1991-2010 0.220 0.212 0.227 0.216 0.290 0.303 ypc (0.033) (0.053) (0.034) (0.052) (0.038) (0.062) -0.094 -0.052 -0.102 -0.060 -0.027 0.019 rer (0.026) (0.038) (0.026) (0.038) (0.032) (0.046) 0.008 0.008 rl (0.004) (0.004) 0.064 0.093 debt (0.019) (0.037) R 2 0.491 0.397 0.502 0.413 0.534 0.438

Current account determinants (III) Deficit countries 1982-2010 1991-2010 1982-2010 1991-2010 1982-2010 1991-2010 0.032 -0.020 0.018 -0.021 -0.068 -0.093 ypc (0.014) (0.019) (0.013) (0.019) (0.027) (0.030) -0.232 -0.241 -0.229 -0.251 -0.200 -0.228 rer (0.016) (0.020) (0.015) (0.022) (0.017) (0.019) -0.001 -0.004 rl (0.003) (0.004) -0.047 -0.044 debt (0.011) (0.014) R 2 0.751 0.863 0.802 0.864 0.784 0.877

Higher German wages? • Deceleration of unit labour costs improved competitiveness – High productivity, low wage growth – Deflation in deficit countries avoided by higher wage increases? • Does not necessarily reduce imbalances – Deterioration of competitiveness not feasible – Export performance relies on investment goods – Export shares to euro area did not increase

Export shares 10 30 EL (lhs) IE (lhs) PT (lhs) ES (lhs) DE (rhs) 8 28 6 26 4 24 2 22 0 20 1995 1997 1999 2001 2003 2005 2007 2009

Policy implications • Imbalances driven by competition variables – Effect most pronounced for deficit countries • Reduction of imbalances requires asymmetric policy response – Deficit countries have to lower unit labour costs • Due to higher real interest rates, switch to more labour intensive production in deficit countries required – Capital inflows can stimulate wage growth in surplus countries

Euro area asymmetries I

Euro area asymmetries II

Euro area asymmetries III

Performance Germany I

Performance Germany II

Performance Germany III

Performance Germany IV

Performance Germany V

Performance Germany VI

Performance Germany VII

Germany – Perceived risks • Tense fiscal situation worldwide and, particularly, in the euro area • Consolidation of public budget (euro rscue packages inc. ECB exposure, • Re ‐ emerging capital market tensions (US, China, euro area) • Too early versus too late exit from stimulus measures • EUR exchange rate: pain threshold?

Germany – Perceived risks Have become smaller: • Effects of the Japanese disasters still unclear • Increasing prices for commodities (oil, food, metals) • Germany: continuously high dependency on exports (IMF VAR analysis: Germany no origin but only transmitter of positive demand shocks)