Revisiting the factors behind European external imbalances

Abstract

In this paper, we develop four hypotheses for the origins of European imbalances in the context of the European economic integration process. To test the validity of our hypotheses for Germany and Spain, we implement an Autoregressive Distributed Lag bounds testing approach. According to our results, in the German case, economic and financial integration and non-price competitiveness have played a key role in the evolution of the external balance, whilst for Spain, the external balance is related to catching-up. In addition, there is no evidence of a long-run relationship between public finance and external imbalances. We derive important policy implications. On the one hand, deficit countries should ensure that the capital inflows from abroad are allocated to industries with high-added value. On the other hand, surplus countries require the implementation of an expansive economic policy, to lessen the burden of deficit countries when trying to address external imbalances.