Estimating the effect of the EMU on current account balances: A synthetic control approach

- This paper estimates the causal effect of the EMU on current account balances.
- I use the synthetic control method to construct counterfactual balances.
- I find that the EMU caused divergence in member state current account balances.
- The results suggest the EMU affected current accounts through multiple channels.
- Institutional changes may be required to avoid the reemergence of imbalances.

The European sovereign debt crisis wrought major political and economic damage on the European Monetary Union (EMU). This led to a reassessment of the pre-crisis period of economic growth and stability in the EMU, shifting attention to the macroeconomic imbalances that emerged between member states, especially those in current account balances. This paper uses macroeconomic data on OECD economies and a new statistical approach for causal inference in observational studies-the synthetic control method-to estimate the effect of the EMU on the current account balances of individual member states. This 'counterfactuals' approach provides strong evidence that the introduction of the EMU was responsible for the divergence in current account balances among member states in the run-up to the euro crisis. The results suggest that the EMU effect operated through multiple channels and that fundamental changes to the institutional framework of the EMU may be required to safeguard the currency union against a reemergence of dangerous external imbalances in the future.