A panel VAR analysis of macro-financial imbalances in the EU

We investigate the interactions across current account misalignments, real effective exchange rate misalignments and financial gaps within EU countries, applying a Bayesian panel Vector Autoregression to 27 EU members over the period 1994-2012. We find that, for the euro area, the reaction of current account misalignments to a shock in the real effective exchange rate misalignments is the largest. In non-euro area countries and euro periphery an increase in current account misalignments leads to a temporary increase in the real effective exchange rate misalignments, lowering competitiveness and thus amplifying current account fluctuations. For the core, increase in the rate or an expansion of the financial gap may help rebalancing the current account. In the central eastern european members, an increase in the real effective exchange rate misalignments may bring larger current account deficits in the medium-long run. Different policies should be applied to different countries in order to reach a balanced current account and to move close to the equilibrium level of the real effective exchange rate, given real and financial fluctuations. The different directions of transmissions are crucial for defining the right path towards equilibrium and they should be taken into account.(c) 2021 Elsevier Ltd. All rights reserved.

Automated summary

This study investigates the interactions between current account misalignments, real effective exchange rate misalignments, and financial gaps among EU countries. The results reveal that in the euro area, the reaction of current account misalignments to a shock in the real effective exchange rate misalignments is the largest. In non-euro area countries and the euro periphery, an increase in current account misalignments leads to a temporary increase in the real effective exchange rate misalignments, amplifying current account fluctuations. Different policies should be applied to different countries to achieve a balanced current account and move closer to the equilibrium level of the real effective exchange rate, considering real and financial fluctuations.