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External Imbalance Essay

1062 words - 5 pages

3) What is the external imbalance refer to, why is it an issue in EZ/ And how it is related to the saving, investment relationship as discussed in the open economy chapters of the textbook?
External imbalances refers to a situation where some countries have current account surpluses compared to other countries with current account deficits. External Imbalances are reflected in trade imbalances(which are driven by labor wage differentials, competitiveness differences and differences in absorption), current account imbalances and external debt.
Since the formulation of the EUROZONE, there has been a difference of sorts, some countries for example Germany and France have benefitted and saw ...view middle of the document...

 The reasons for these imbalances could be in the differentials of the cross country domestic demand growth, spurred by financial integration, low interest rates, and the stronger potential for economic convergence that came along with the euro. Another reason could be the loss of competitiveness in the EZ periphery, as a result of wage growth inconsistent with underlying productivity trends .
Since a country's current account balance equals the difference between domestic saving and investment, these developments were mirrored in changes in saving and investment patterns.
In the Euro Zone, tighter credit conditions, rising labor market uncertainty and efforts to make up for sudden wealth losses causes savings to rise from their pre-crisis levels. However, this was generally more than offset by lower government saving, so that national saving rates fell.
Since the fall in the national saving rate was, on average, smaller in external deficit countries, it contributed to a decline in external imbalances. At the same time, total investment rates fell substantially in many countries, driven by falling business investment and, in those countries that had experienced house price and construction booms, falling residential investment.
Since the fall in investment was generally larger in countries with current account deficits, these developments also contributed to a decline in external imbalances in the EZ.

4) What is the unit labor cost that is used as a measure of competitiveness? Why is it important?
The Unit Labor Cost can be defined as the ratio between the workers total compensation or money wage (i.e. the nominal wage rate plus all the other labor related costs such as social security, pensions, insurances, etc) to the total labor productivity , it reflects the amount of output received related to the wages. On the one hand, the ratio shows the amount of labor costs needed to produce one unit of GDP and on the other hand unit labor cost indicates the ratio of labor costs to productivity in the production of GDP.

Countries use it as a measure of competitiveness because they track the relationship between the total labor costs to the productivity of the workers. If a country's ULC increases than those compared to other...

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