If current account improvements are being driven mainly by lower imports in a weak economy, they are likely to unwind when the economy recovers and imports rise again. But if they are being driven by structural changes – such as competitiveness gains and reallocation of resources towards productive sectors – they are more likely to be sustainable in the steady state, both externally and internally. All four aspects are integral to the rebalancing process. Sustainable rebalancing requires that adjustment is stable, symmetrical and structural. Only under those conditions can all economies achieve full employment in a way that is robust to global developments. So what do we see in the euro area today? Progress with rebalancing The imbalances that built up in the euro area before the crisis were sizeable. Current account deficits in the five (former) programme countries – Greece, Portugal, Ireland, Spain and Cyprus – had doubled from, on average, around 5% of GDP in 2000 to about 10% of GDP in 2008. Moreover, those imbalances were financed largely by volatile, debt-based cross-border flows. That left several countries vulnerable to a rapid reversal in financing, with little ex-post sharing of risks between private borrowers and lenders – a so-called “sudden stop”. Since then, we have seen considerable flow improvements, especially in the countries that entered the crisis with large current account deficits. Deficits in the (former) programme countries have adjusted dramatically. On average they are in balance today. Only Greece and Cyprus are still recording small deficits, while the other countries have moderate surpluses.

And it would also allow non-viable firms to fail faster, supporting reallocation to more productive ones. This is the message of a recent analysis from the European Commission, which finds that a good insolvency framework is associated with speedier adjustment of non-performing loan ratios.12 Symmetrical rebalancing That said, it is also clear that sustainable rebalancing cannot only involve measures in crisishit countries. Rebalancing has to be somewhat symmetrical, i.e. surplus countries also have a contribution to make. Such a contribution is partially about strengthening domestic demand, though we know that spillovers to crisis-hit countries through higher imports are likely to be small.13 But what is more important, in my view, is the role of surplus countries in supporting euro area price stability – i.e. an inflation rate of below but close to 2%. This would allow the remaining relative price changes within the euro area to take place against a higher nominal bar. And that would in turn avoid deflationary nominal adjustments that raise real interest rates.14 So how could this be achieved? As I already mentioned, wages have been rising more robustly in surplus countries, which is welcome and consistent with rebalancing. Yet some argue that more is still needed in terms of demand-side policies. Such measures would no doubt support euro area price stability. But they would have very limited impact on potential output and the permanent income of households. One can therefore question how much they would, in isolation, contribute to a sustainable rebalancing over the medium term.