Abstract
This paper investigates the drivers of the divergent current account balances that emerged in the EMU in the run-up to the most recent crisis. A time-varying structural VAR model identied via long-run and sign restrictions is set up in order to integrate the partly competing hypotheses discussed in the literature into a single structural framework. Besides excessive domestic demand, mismatched monetary policy and shocks to price competitiveness have been driving the current account divergence during the rst ten years of EMU, whereas supply side eects are negligible. The rapid current account rebalancing within EMU is found to be attributable mainly to demand side adjustment, while in addition the adverse eects of deteriorated price competitiveness have diminished.
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