Balance of payments in the European periphery

The countries of the European periphery are experiencing a balance of payments crisis stemming from persistent current account deficits and sharply lower private capital inflows, a condition known as a sudden stop. In countries with fixed exchange rates, sudden stops typically drain foreign reserves, forcing currency depreciation which eventually shifts the current account from deficit to surplus. However, the sudden stop has not prompted the European periphery countries to move toward devaluation by abandoning the euro, in part because capital transfers from euro-area partners have allowed them to finance current account deficits. A balance of payments crisis typically arises when a country can’t finance its foreign transactions. A country’s balance of payments can be separated into two main parts: the current account, which reflects the trade balance in goods and services; and the financial account, which reflects the balance on net international financial transactions. In turn, the financial account can be broken down into, one, the balance on international private capital flows; and, two, changes in official holdings of foreign reserve assets, such as gold, foreign currency, and foreign sovereign debt. Three things are noteworthy about current account deficits. First, they occur when a country’s imports