Current Account Imbalances in the Euro Area: The Role of Monetary Policy

Abstract

This paper provides an alternative approach in explaining current account imbalances within the euro area. The inability of the ECB to react to disparities in inflation and economic growth between EMU members results in persistent real interest rate differentials, which in turn cause divergent current accounts among EMU member states. Using Taylor rules we assess an optimal interest rate for each EMU member separately. The deviation between realized euro and optimal country-specificc interest rate, employed in a panel estimation, exhibits a significantly strong impact on current account imbalances and proves to be robust to various specifications.