Exchange rate and macroeconomic adjustment in southern eurozone countries

In this paper, we estimate panel cointegration and VEC models to show that, during the pre-euro period, devaluation and/or depreciation of the domestic currency were a recurrent weapon for macroeconomic adjustment in Greece, Italy, Spain and Portugal. Moreover, we perform panel Penn-effect regressions using a sample of 114 countries to prove that during the period 1970-2011 the four countries incurred misalignments of remarkable size and variability in their real exchange rates. All in all, our results reveal that for several decades the four countries needed to use their nominal exchange rate as a tool of macroeconomic adjustment. Since variations of the nominal exchange rate within the EMU are no longer an option, the four southern eurozone countries should accomplish the necessary structural reforms to avoid new and painful internal devaluations in the coming years.