External Imbalances and Sovereign Debt Crisis: Eurozone Countries

The purpose of this article is to formally link the external imbalances to the sovereign debt crisis that the EMU has been experiencing since 2009. Based on Capital enhanced Equilibrium Exchange Rate approach, which links the goods market to the capital market via the expected exchange rate, we show that when a country belonging to a monetary union faces an external imbalance vis-à-vis another member country, the corresponding interest rate differential tends to increase. Moreover, when these imbalances persist, they can trigger a balance of payments crisis. Our results indicate that such a phenomenon seems to be at pay for European countries under international financial assistance.