What drives the German current account? and how does it affect other EU member states?

We estimate a three-country model using 1995-2013 data for Germany, the Rest of the Euro Area (REA) and the Rest of the World (ROW) to analyze the determinants of Germany’s current account surplus after the launch of the Euro. The most important factors driving the German surplus were positive shocks to the German saving rate and to ROW demand for German exports, as well as German labour market reforms and other positive German aggregate supply shocks. The convergence of REA interest rates to German rates due to the creation of the Euro only had a modest effect on the German current account and on German real activity. The key shocks that drove the rise in the German current account tended to worsen the REA trade balance, but had a weak effect on REA real activity. Our analysis suggests these driving factors are likely to be slowly eroded, leading to a very gradual reduction of the German current account surplus. An expansion in German government consumption and investment would raise German GDP and reduce the current account surplus, but the effects on the surplus are likely to be weak.