External adjustment with a common currency: The case of the Euro Area

Abstract

This paper analyzes the behaviour of the external adjustment path for the fourmain economies in the euro area. I find a structural break in the behaviour of thenet external position at the time of the introduction of the euro for France, Italyand Spain, pointing out that the inception of the common currency changed theirexternal adjustment process. Germany does not show this structural break, beingits external position more affected by other events such as the country reunificationin 1989. I also find that France and Italy will adjust the net external position mainlythrough the valuation component, while Germany and Spain will restore their externalbalance mostly through the trade component. The common currency area exacerbatedGermany’s net creditor position as the evolution of the euro has reacted to the externaladjustment needs of debtor countries such as Italy and Spain.