What Drives EMU Current Accounts? A Time Varying Structural VAR Approach

Current account imbalances have been a decisive feature of the European banking and sovereign debt crisis. This paper investigates the drivers of euro area current accounts, their divergence and subsequent rebalancing, within a structural model accommodating potential regime changes at the introduction of the common currency and the onset of the financial crisis. In the run-up to the crisis domestic demand shocks account for a substantial fraction in the current account deficits of EMU periphery countries --- the mirror image of Germany's foreign demand driven surplus. While supply side factors also explain part of the current account deficits in Italy, Spain and Portugal in the years before the crisis, shocks to price competitiveness or foreign demand played a minor role for those economies. The adjustment subsequent to the financial crisis was borne partly by a contraction in demand in the economies running deficits, but is also due to adverse supply shocks implying lower growth perspectives