External Imbalances, Gross Capital Flows and Sovereign Debt Crises

Sergio de Ferra

No 726, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: The experience of the European monetary union has been characterized by three distinctive facts. First, core and periphery countries ran widening current account surplus and deficit positions, after the inception of the union. Second, core countries intermediated gross capital flows from the rest of the world, which in turn financed deficits in the periphery. Finally, a sovereign debt crisis took place, affecting multiple countries and causing severe recessions. I argue that institutional features of the European Economic and Monetary Union are responsible for the observation of imbalances, intermediation and pervasive crises. First, I show in a theoretical model that subsidies on holdings of euro-denominated assets contribute to all three phenomena. Second, I build a dynamic model of an economic union with trade in goods and financial assets. In the model, the introduction of a subsidy on cross-border asset holdings generates predictions for net and gross asset flows that quantitatively replicate the euro area experience. The model features a novel theoretical mechanism magnifying the severity of a debt crisis in an economic union, due to the joint presence of financial and trade linkages among union members. This mechanism is likely to have exacerbated the recent recession in the euro area periphery.

Date: 2017
New Economics Papers: this item is included in nep-dge, nep-eec, nep-ifn and nep-opm
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Citations: View citations in EconPapers (5)

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Journal Article: External Imbalances, Gross Capital Flows, and Sovereign Debt Crises (2021)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:726

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