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Rebalancing the Euro Area: The Costs of Internal Devaluation

Stockhammer, Engelbert and Sotiropoulos, Dimitris P. (2012). Rebalancing the Euro Area: The Costs of Internal Devaluation. Post Keynesian Economics Study Group, Cambridge.

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Abstract

This paper investigates the economic costs of rebalancing current account positions in the Euro area by means of internal devaluation. Internal devaluation relies on wage suppression the deficit countries. Based on an old Keynesian model we estimate a current account equation, a wage-Phillips curve and an Okun’s Law equation. All estimations are carried out for a panel of twelve Euro area members. From the estimation results we calculate the output costs of reducing current account deficits. Greece, Ireland, Italy, Portugal and Spain (GIIPS) had, on average, current account deficits of 8.4% of GDP in 2007. To eliminate these current account deficits, a reduction of GPD by some 47% would be necessary. In principle there are two ways that trade imbalances could be resolved: deflationary adjustment in the deficit countries or inflationary adjustment in the surplus countries. Presently, the burden of adjustment is exclusively on the deficit countries. Our results indicate that the economic costs of this adjustment to those countries are equivalent to the output loss of the Great Depression. An adjustment of the surplus countries would increase growth and it would come with higher inflation, but it would allow rebalancing without a Great Depression in parts of Europe.

Item Type: Other
Copyright Holders: 2012 Engelbert Stockhammer and Dimitris P. Sotiropoulos
Keywords: rebalancing; euro area; current account; Phillips curve; Okun’s law
Academic Unit/School: Faculty of Business and Law (FBL) > Business > Department for Accounting and Finance
Faculty of Business and Law (FBL) > Business
Faculty of Business and Law (FBL)
Research Group: Innovation, Knowledge & Development research centre (IKD)
Item ID: 39357
Depositing User: Dimitris Sotiropoulos
Date Deposited: 30 Jan 2014 14:29
Last Modified: 07 Dec 2018 22:05
URI: http://oro.open.ac.uk/id/eprint/39357
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