A simple econometric framework is presented linking current account balances of euro area countries
to intra and extra euro area competitiveness, cyclical positions, fiscal positions and the oil price. The
framework is then used to cyclically-adjust observed current account balances and illustrate the scale of the
additional adjustments to competitiveness and/or fiscal balances required in the euro area periphery to
bring structural current account balances to levels compatible with sustainable net external debt levels. In
Spain and Portugal, cost competitiveness relative to the rest of the euro area would need to improve by
about 30%, and by more than twice that in Greece. In peripheral countries, a combination of structural
reforms to boost productivity and enhance the flexibility of labour markets, ambitious fiscal consolidation
and reductions in labour taxes could substantially facilitate the rebalancing process and reduce the extent to
which the burden of adjustment is reliant on further prolonged demand weakness. Surplus and/or strong
competitiveness countries could help by likewise making labour and product markets more flexible,
accepting above-normal inflation for an extended period and boosting demand, perhaps through reduced
fiscal austerity.
