Introduction:

The economic crisis in the euro area continues to galvanise its member states’ governments in 2011. Greece and increasingly other countries in the so-called periphery of the monetary union are facing the threat of defaulting on their debt. Nearly all euro area governments are currently (July 2011) in breach of the public deficit and debt criteria enshrined in the European Stability and Growth Pact.

Over and above the pressing default problem, exacerbated by the lack of country-level exchange rate flexibility and monetary policy, euro area governments need to achieve the longer-term macroeconomic stability required for a functioning monetary union. This stability, which includes the reduction of external imbalances, is widely recognised as essential for the euro area to achieve robust growth. Without growth it is feared that unemployment cannot be reduced, foreboding more social unrest and possibly threatening the very project of European integration. In striving for stability, euro area governments therefore face two challenges: the reduction of public deficits, and the reduction of external imbalances. However, while the public deficits are in the limelight, attention paid to external imbalances has been meagre. Moreover, despite recent European Commission interest in correcting 'excessive imbalances', the governments still largely ignore the importance of reducing current account imbalances in a coordinated manner. This is evident in their latest version of national Stability Programmes (SPs) from April 2011.1 If these SPs reflect both perceptions about economic developments and intended policies of European governments, then analysing them helps in evaluating whether the euro area is on track to stability and overcoming the crisis.

In this paper, we argue that the projections for achieving stability in the current SPs are very likely too optimistic.2 By ignoring the importance of external rebalancing and assuming an overly buoyant world economy, the SPs either forecast unrealistic growth rates or improbably successful fiscal consolidation. This emerges from using merely the logic of macroeconomic accounting relationships to analyse the three financial balances (public, private, foreign) of the Eurozone countries and conducting a simple simulation of rebalancing. We conclude that failure to consider external imbalances is likely to entrench existing instability in the euro area and portends long-lasting economic stagnation. Further, a symmetric rebalancing effort would slow down fiscal consolidation in the current account surplus countries, but would address both macroeconomic challenges and thereby not only allow for consolidation in the medium term but also lead to the desired stability. The final brief sketch of feasible alternative policy recommendations that would address both challenges (sustainability of public deficits and current account positions) in lieu of neglecting one (current account rebalancing) requires a greater sophistication of the economic argument and thus involves more judgment. Important open questions remain, above all the challenge of reducing differences in price and non-price competitiveness in the absence of nominal exchange rates, which lie outside the scope of our accounting logic argument.