Sectoral allocation and macroeconomic imbalances in EMU
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Sectoral allocation and macroeconomic imbalances in EMU Niels Gilbert1 · Sebastiaan Pool1,2
© Kiel Institute 2020
Abstract The study documents how, over 1996–2008, large capital inflows in Southern Europe coincided with broad-based growth of the nontradable sector, extending beyond the construction and real estate sectors. The authors present a tractable twosector, two-region (‘North’ and ‘South’) model of a monetary union, in which they show how the sharp, permanent, fall in Southern real interest rates that occurred in the run-up to EMU can explain the Southern consumption boom, wage growth, growth of the nontradable sector, and deteriorating external position. Upward pressure on the EMU-wide interest rate induces an opposite process in North. Consequently, both real exchange rates and external positions of the two regions diverge. Including a third country with a flexible exchange rate vis-à-vis the euro amplifies the effects of monetary integration in South, while dampening them in North. The study confirms the key model predictions using a panel-BVAR for the euro area and investigate various policy reforms to facilitate the ongoing rebalancing process in the eurozone. Keywords EMU · Monetary integration · Current account imbalances · Sectoral allocation JEL Classification F32 · F34 · F36 · F45
Electronic supplementary material The online version of this article (https://doi.org/10.1007/s1029 0-020-00388-w) contains supplementary material, which is available to authorized users. * Niels Gilbert [email protected] Sebastiaan Pool [email protected] 1
De Nederlandsche Bank, PO Box 98, 1000 AB Amsterdam, The Netherlands
2
University of Groningen, PO Box 800, 9700 AV Groningen, The Netherlands
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N. Gilbert, S. Pool
1 Introduction In the run-up to the introduction of the euro, both real and nominal interest rates in the Southern members of the Economic and Monetary Union (EMU) decreased markedly. This induced major capital flows from the North to the South, which were initially considered to be largely benign.1 In retrospect however, the inflow of capital mainly fueled a boom of domestic lending and construction, contributing little to productivity growth or business cycle convergence.2 As the discrepancy between the external debt level and the capacity to repay kept growing, eventually the solvency of the recipient regions came under pressure (see Giavazzi and Spaventa 2010). Whereas there exists a fairly broad consensus regarding this narrative (see e.g. Baldwin and Giavazzi 2015), less is known about how the sectoral allocation of capital came about. It is therefore also unclear whether the developments in the first decade of EMU were an unfortunate one-off or something that could have been foreseen and possibly prevented. In this paper, based on a detailed breakdown of the share of production that is absorbed domestically, we document how the growth of the nontradable sector in Southern Europe was a broad-based phenomenon extending beyond the construction- and real estate se
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