The Balance of Payments Crisis in the Euro Area Periphery

March 10th, 2014
in econ_news

by Matthew Higgins and Thomas Klitgaard - Federal Reserve Bank of New York

Countries in the euro area periphery borrowed heavily from abroad in the years leading up to the sovereign debt crisis, largely to finance increased consumption and housing investment. When the crisis hit in 2010, capital flight by private investors forced these countries to bring domestic spending back into line with domestic incomes—the same adjustment required of countries facing a typical balance of payments crisis. Nevertheless, adjustment to the pullback of private capital was not as harsh as might have been expected, owing to the workings of the euro area’s system for managing cross-border payment imbalances between regional commercial banks. This system, known as Target2, offset much of the capital flight with credits extended collectively by euro area central banks to central banks in the periphery.

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