Do current account deficits matter inside a monetary union? The answers are “no” and “yes”: no, because there cannot be a currency crisis; and yes, because there cannot be a currency crisis. Where unsustainable divergences in competitiveness emerge, adjustment occurs largely through changes in relative nominal costs, particularly of labour. The bigger the required adjustment, the greater the pain.

The challenge posed by divergent competitiveness inside the eurozone has been widely discussed for the case of Italy. But Spain is even more interesting. Spain, unlike Italy, has been an enormous economic success; Spain, unlike Italy, has a huge current account deficit; Spain, unlike Italy, has enjoyed a vast construction boom. But Spain, this time like Italy, has low productivity growth and deteriorating external competitiveness.  Read more