Slow but steady? Achievements and shortcomings of competitive disinflation within the euro area

There is a widespread perception that imbalances within the euro area are not adjusting, the major difficulty being that the competitive disinflation processes required in deficit countries are painful, while no strong incentives are always available in surplus countries to reduce their excess savings.

Recent evidence, however, provides some encouragement. Not only labour cost developments are increasingly supportive of more rebalancing down the road, but recent reforms in a number of euro-area countries appear to be bringing fruits in terms of reduced downward wage rigidities. Although the necessary adjustment for some deficit countries is still considerable, there could be light at the end of the tunnel provided that the process is supported by consistent wage developments in surplus countries and a recovery in productivity growth in take place in deficit countries. Improved potential growth in deficit countries is key to prevent the risk of foreign debt deflation and unstable Net International Investment Positions down the road. For this to happen, private capital will have to start flowing downhill again. To this purpose, a fast and effective adoption of a Single Supervisory Mechanism and moving eventually towards a banking union will be a key step.