In Need of Sectoral and Regional Rebalancing in the Euro Area: A Euro Area Sectoral Accounts (Flow-of-Funds) Perspective

Abstract

The paper looks at the debt crisis through the lenses of the Euro area accounts. It starts from the traditional analysis of the sectoral’s financial balances (savings minus investments), describing their “rotation” during the boom, the crisis and the recovery. It then moves on to emphasise the regional differences in sectoral balances, distinguishing two regional groupings: external surplus and deficit countries. The boom period is mostly marked by a pronounced swing into deficit of the private sector in deficit countries, which contrasts with the fairly stable private sector surpluses in surplus countries, resulting in a widening gap in external balances between the two groups. However, the abrupt reversal in private sector financial balances in the deficit group after Lehman hardly changed the current account surplus/deficit configuration of these two groupings over 2008–2011, but instead was largely compensated by a larger gap in government deficits. Taking another perspective, the pre-crisis gradual widening gap in external balances between these two groupings can be seen as originating largely from increasingly large differentials in national saving, rather than in national investment. This increasing national saving differential mostly reflected increased saving differentials of the corporate sector up to 2007 (rather than households’ or governments’) that have reversed only to a limited extent since then. This in turn resulted from the emergence of a considerable gap in gross operating margin between the two regional groupings, with much higher margins in surplus countries. This reflected the faster increase in wages in the deficit countries compared to surplus countries, in excess of what would be justified by productivity and/or growth differentials. Our analysis suggests that the very large wage gap (in the order of 15–17 %) that had emerged would need to be reduced as a precondition to macro-rebalancing. The paper highlights the mechanism by which the free circulation of savings in a (financially integrated) monetary union distorts price/wage structures, in the absence of fully integrated goods and labour markets. This contrasts with a more optimistic interpretation that suggested that greater circulation of savings within the euro area was a welcome consequence of increased financial integration, celebrating the end of the Feldstein-Horioka puzzle. The distortion of the relative price/wage structure, away from initial equilibrium, is in itself not a difficulty in a common currency area, unless the lack of price/wage flexibility prevents, once capital inflows stop or even starts reversing, a rapid return of prices and wages to their original equilibrium level.

The views expressed are those of the presenter and should therefore not be reported as representing the views of the European Central Bank.