Current Account Imbalances and Real Exchange Rates in the Euro Area*

TLDR

Global current account imbalances have been a focal point for policymakers, yet the diverging balances among individual euro area countries have received less attention. The study aims to examine how real exchange rates influence current account adjustments in EMU countries. The authors model the dynamics of current account adjustment and real exchange rates in EMU countries. After controlling for income growth, the relationship between real exchange rates and current accounts is substantial and nonlinear, and real exchange rates provide additional insights beyond income catch‑up effects.

Abstract

Abstract Global current account imbalances have been one of the focal points of interest for policymakers during the last few years. Less attention has been paid, however, to the diverging current account balances of the individual euro area countries. In this paper we consider the dynamics of current account adjustment and the role of real exchange rates in current account determination in the EMU countries. After controlling for the effects of income growth, we find the relationship between real exchange rates and current accounts to be substantial in size and subject to nonlinear effects. We find that real exchange rates can offer further insights, beyond the effects of the income catch‐up process, relevant to current account determination in the EMU.