Interest Rate Convergence, External Balances and the Euro Crisis

Abstract

Typically, the catching-up process between rich Northern Europe and poor Southern Europe and the diverging cost competitiveness between the two regions are considered alternative explanations for the widening current account imbalances in the euro area. This paper proposes a new explanation for the imbalances which led to the 2009 euro crisis i.e. large interest rate differentials among the EMU-12 countries which prevailed before the adoption of the euro. This finding suggests that the euro crisis was, at least to some extent, a consequence of the initial convergence shock.