Rue de la Banque no. 31: What caused current account imbalances in euro area periphery countries?

External imbalances may exacerbate the vulnerability of countries. As regards euro area periphery countries, the widening of these imbalances began in 1996, before the introduction of the euro. This Rue de la Banque tests different explanations for the build-up of these imbalances since 1996. Account is taken of the role played by changes in economic agents’ expectations which could have been triggered by the announcement, in December 1995, of the exact timeline of the transition to the single currency. Current account and real exchange rate imbalances in the euro area periphery countries were largely driven by an anticipated decrease in relative (to the core countries) external borrowing costs and not by a catching-up process (i.e. capital was not flowing simply towards countries with higher current or expected rates of return).