Wednesday, June 27, 2012

A reason the Euro failed?

The Euro is failing because of chronic current account imbalances between Northern and Southern Europe. But what is the reason for these imbalances?

Below I have plotted the homeownership rate versus the current account balance as a % of GDP for a set of major economies. The data is for 2004/2005, so it is before the crisis struck. There looks to be a reasonable correlation here, with high rates of homeownership predicting trade deficits.

The next chart shows the same data in a different style. Note that Greece, Ireland and Spain have some of the highest rates of homeownership in the OECD, while Germany has one of the lowest.

The question here is why high rates of home ownership go along with trade deficits. It's possible that people who own their own home feel more confident and are more willing to spend. I think it is more likely that easy consumer credit is responsible for both the high rate of home ownership and the excessive consumption that leads to trade deficits.

Another point here is that the Euro brought together diverse countries with different economic cultures. Maybe things would have worked better if there had been a single financial regulator for Europe.

Data sources: 2004 Homeownership: from OECD
                           2005 Current account balance from OECD