Current Account Imbalances in the Monetary Union and the Great Recession: Causes and Policies

Current account imbalances within the eurozone are at the roots of its economic crisis. We argue that, though relevant, emphasis should shift from competitiveness to differential rates of growth of domestic demand as its chief explanatory factor. Euro core countries have experienced a shortage of domestic demand, with wage restraint playing a key role. This has led them to experience a current account surplus, which could not be understood independently of a buoyant domestic demand in the peripheral countries, funded with private debt. As a byproduct of that strong demand, the periphery suffered from wage inflation and a loss of competitiveness. This dual growth pattern is unsustainable as indebtedness cannot go on without any limit. Neither wage cuts nor fiscal austerity in the periphery will help to solve this mess: although trade balance would be restored, it would lead to a negative shock in aggregate demand, threatening their ability to settle debts at due dates.