Current account imbalances in the European Union - Can convergence and competitiveness explain the intra-EU current account imbalances

Abstract: The current account within the EU has been balanced on an aggregate level; nevertheless divergences among the members have increased since the introduction of the common currency. This thesis aims to explain the intra-EU current account imbalances (in the period 1993-2013) through the convergence and competitiveness hypothesis. We distinguish between balances towards the EU and the rest of the world, focusing on the former. In order to capture the dynamics of the imbalances two breaks are considered; one for the introduction of the EMU and another for the financial crisis. Moreover, a subsample estimation between deficit and surplus countries are considered. The results contradicted depending on the estimation method. The Feasible Generalized Least Squares (FGLS) estimator provided evidence of income-convergence in the EU and an extra effect for the EMU countries. Furthermore, it showed that the financial crisis affected the imbalances in the EU countries negatively, however the EMU countries were affected positively. Using the fixed effects estimator, the competitiveness hypothesis was able to explain the current account imbalances in EU, but no evidence for further impact of the EMU countries. For the deficit countries the FGLS found evidence that the financial crisis affected the trade balances negatively, and that the EMU countries trade balances were less affected. Evidence for income-convergence was found but no extra effect for the EMU countries. The contradicting results can be explained by the omitted variables bias and structural changes in the determinants that the financial crisis might have given rise to.