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International Monetary Fund. Research Dept.

output due to lowered demand has likely been matched by a decrease in potential output. However, there is some uncertainty about the latter, and there is the risk that flow imbalances will widen again. Second, since flow imbalances have shrunk but not reversed, net creditor and debtor positions (“stock imbalances”) have widened further. In addition, weak growth has contributed to increases in the ratio of net external liabilities to GDP in some debtor economies. These two factors make some of these economies more vulnerable to changes in market sentiment. To mitigate

International Monetary Fund. European Dept.

External Rebalancing in the Euro Area: Developments and Policies 1 Since the crisis, the euro area current account has moved from rough balance into a clear surplus. The rebalancing underlying this shift has been highly asymmetric, with some debtor economies (Cyprus, Greece, Ireland, Italy, Latvia, Portugal, and Spain) seeing large improvements in their current accounts (sometimes into surplus), while many creditor economies (Austria, Belgium, Finland, Germany, Luxembourg, and the Netherlands) have largely maintained their surpluses. In this context, the

Mr. Luca A Ricci, Mr. Jonathan David Ostry, Mr. Jaewoo Lee, Mr. Alessandro Prati, and Mr. Gian M Milesi-Ferretti

only a few assumptions about the economy’s potential growth rate, inflation rate, and rates of return on external assets and liabilities. This simple and transparent structure makes it a natural reference point against which to compare more sophisticated econometric approaches. The implications of the ES approach are straightforward. Debtor economies that grow faster can afford to run larger current account deficits and smaller trade balances without increasing their ratio of external liabilities to GDP. Also, high rates of return on external assets and liabilities