External imbalances in emerging and advanced European countries

Abstract

This paper aims to explain some developments in current accounts across advanced and emerging European countries with a fixed exchange rate. Our main goal is to identify key factors affecting the external imbalances. This assessment of the cause of external imbalances will help us understand what has to be changed in European economies to recover the external balances going forward. We estimated a panel VAR model over the period 1999 to 2014 for a sample of 11 European countries that were split into two groups: advanced and emerging. The obtained results show that the real effective exchange rate has a negative effect on the current account balance in both groups of countries, although the effect is more pronounced in emerging than in advanced countries. Other variables such as the budget balance, economic growth, and output gap affect current account balance positively in advanced countries and negatively in emerging countries. Economic activity captured by output gap explains the highest portion of current account variations in emerging countries. In advanced countries, in addition to economic activity, the real exchange rate also plays a prominent role in current account imbalances.