Euro area current account imbalances: A tale of two financial liberalizations

Abstract

This paper explores the extent to financial liberalization in the euro area had a differential impact on members’ current account positions. Theoretically, it builds on an inter-temporal consumption model augmented with household heterogeneity. Low/middle income groups are impatient and constrained, whilst high-income groups are patient and under no constraint. Increased access to international credit in previously financially repressed countries implies a relaxation of collateral constraints specifically for the (low-skilled) low/middle-income group, who differently from high-income agents borrows to finance current consumption. It follows that financial liberalization is associated with deteriorating external positions there where initial levels of financial openness are lowest and the share of the (low-skilled) low/middle-income group with potentially binding collateral constraints largest. The same approach is useful to understand asymmetric current account reversals, which relates to suddenly biting collateral constraints in indebted peripheral countries, where the Great Recession hit disproportionally the low-skilled.