What Drives Current Account and Trade Balances in Euro Area Periphery Countries? A Structural VAR Analysis for Greece, Portugal and Spain.

Abstract: In the years before the Great Recession of 2008-2009 large current account deficits emerged in some countries of the euro area periphery. As a consequence, sizeable net foreign debt positions were accumu- lated, which contributed to the outbreak of the European Sovereign Debt Crisis (Lane and Milesi-Ferretti 2011). While external balances in Greece, Ireland, Italy, Portugal and Spain were restored in recent years, much research effort has been devoted to determine the underlying reasons of these developments. After identifying trade balance changes as the most important driver of current account balances in the euro area periphery, this thesis enhances the existing literature by determining the importance of demand and price competitiveness factors for the net exports of Greece, Portugal and Spain in a structural VAR framework. The main conclusion from analysing impulse response functions and from employing a forward error variance decomposition is that domestic demand is the most important driver of trade balance changes. While price competitiveness matters to a smaller extend as well, over the full sample period foreign demand does not have a significant effect on net exports. These results are robust to different model specifications. Last, by studying subsamples of the baseline data period, some indicative conclusions are drawn on the determinants of net exports in the time before and after the Great Recession for Spain and Portugal.