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The IMF recently released its World Economic Outlook for 2013 which among other things also includes some quite interesting research. I will focus on two issues, the divergence of politics between developed and emerging economies and the current account developments in the periphery countries

Divergence of Politics

Although world GDP has recovered since the Great Recession with the same pace as past recessions, this recovery masks different paths between developed and emerging economies with the former actually never achieving a reutrn to the output levels before the crisis:


Although monetary policy has actually been very accommodative during the latest downturn (compared with previous recessions), the same did not happen for real government expenditures. These were stable in developed countries and increased much faster than past recoveries in emerging countries. It seems that countries which adopted contractionary policies in terms of government expenditures actually experienced the heavier losses in output, mainly the Euro periphery and the UK.

Real Fiscal Expenditures

Although correlation does not prove causation, the above data, coupled with the fact that monetary policy hit the zero level bound since the start of the crisis, point to the importance of fiscal policy to maintain aggregate demand and to large fiscal multipliers (with limited inflationary pressures).

central bank policies

Euro Periphery Current Account Developments

The IMF has done an excellent job of looking into the main drivers of pre-crisis current account imbalances and their post-crisis paths.  I ‘ve looked into Greek data in detail in the past and it seems that the WEO data point to the same conclusions. More specifically:

  • CPI-based REER appreciation for Greece (but for other countries as well) was driven mainly by the NEER rather than CPI (or even ULC) differentials.
  • Most countries were able to actually expand their export-to-GDP ratios driven by small ULC increases in the tradable sectors.
  • What mostly happened was that ULC of the non-tradable sectors increased substantially in all countries (especially in Greece and Ireland) which led to imports growing faster than exports which had a negative effect on the trade balance.
  • Overall current account deterioration (especially for Greece) was driven not only by the trade balance, but also from the income balance as well as transfers. Negative trade balances (absent exchange rate depreciation mechanisms) increased net liabilities with the RoW and led to negative income balances due to increasing interest payments.

pre crisis current account developments

In all countries, housing bubbles played a significant role since house prices increased much faster than the Euro area average and created a wealth effect which allowed domestic consumers to expand their borrowing and finance foreign goods purchases (while also enlarging the construction sectors in the relevant countries). In the case of Greece, the increase in ULC can be attributed to a large part in (almost double) increases in public sector wages which also drove private sector ULCs higher.


A few clear conclusions from the above analysis are that:

  • Monetary policy could have played a large role in closing current account imbalances by lowering interest rates while maintaining the safe status of the securities held by the foreign sector. Lower interest rates would have allowed periphery countries to rollover their external liabilities at low rates and achieve a decline in both their fiscal and income deficits.
  • A large part of the REER imbalances are driven by NEER forces which are basically controlled by the central bank rather than any individual country.
  • The tradable sector did not seem to have actually lost significant competitiveness (as evidenced by the small increases in their relevant ULC) but rather the non-tradable sector grew larger and displayed high increases in wages. As a result, permanently closing current account imbalances will require costly and long-term deflationary policies with large lags while pushing unemployment, bankruptcies and permanent output losses to unacceptable highs in the meantime.
  • A fiscal consolidation targeted at lowering public sector wage costs (through wage freezes and lower employment) in Greece seems logical since the public sector was the main source of the increase in ULCs.

Overall, the nature of the imbalances (large non-tradable sectors with substantial wage increases in the pre-crisis period) called for a stronger role of monetary policy (through lower rates, targeted asset purchases and exchange rate targeting) rather than extensive austerity since the rebalancing process would definitely take a lot of time and involve large domestic costs for the periphery countries.

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Kostas Kalevras

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