Posted by: Dirk | May 14, 2007

Adjustment in the EMU: The case of Spain

In March 2007 the European Commission published a working paper entitled “Adjustment in EMU: A model-based analysis of country experiences”. The authors, Sven Langedijk and Werner Roeger, run simulations on a couple of European Union members which are also part of the currency union. The aim is to compare the very different economic experiences of these EU members. Shocks are introduced into the model which then account for deviations from EU average in a number of variables, including GDP growth, inflation, investment (business and housing).

The short summary for Spain looks like this:

1) Shocks related to the creation of EMU explain GDP and its components as well as inflation in the first 2 to 3 years. The fall in the risk premium also explains a lower permanent consumption level and a more permanent current account deficit (of about 2.5% of GDP)
2) The risk premium cannot explain sustained differences in the growth rate of housing investment. This can only be captured by assuming specific housing demand shocks. Increased housing demand can partially explain high inflation and a rising current account deficit in recent years.
3) On the supply side, low TFP growth of non tradeables and increased competition in tradeables are important explanatory factors for inflation and the external balance in the Spanish economy.
4) The increase in the employment rate is only to a limited extent explained by the shocks considered. Both the population increase and increased competition contribute positively to employment. However the bulk of the increase of the employment rate is generated by a shift in the wage setting rule consistent with the observed decline in structural unemployment. Increased employment in Spain contributes significantly to housing demand, investment and private consumption.

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