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Current Account Imbalances and Financial Integration in the Euro Area Alan Ahearne Bruegel, Brussels and National University of Galway, Ireland Birgit Schmitz University of Bonn Jürgen von Hagen University of Bonn, Indiana University, and CEPR February 2009 Abstract While the current account of euro area as a whole has remained almost balanced in the past two decades, several member countries have sizeable deficits or surpluses. In this paper, we interpret these imbalances as indicators of net capital flows among the euro-area countries and show that these net flows follow differences in per-capita incomes. Our results show that the elasticity with respect to per-capita incomes of net capital flows between euro-area countries and the euro area has increased. This is not the case for net capital flows between non-euro area countries and the euro area, nor for euro-area countries and the rest of the world. We interpret this as evidence for increasing financial integration in the euro area. There is also some evidence suggesting that the introduction of the euro has lead to some financial diversion. Key words: financial integration, current account imbalances, European Monetary Union JEL classification codes: F21, F33, F34, F36 The authors thank Narcissa Balta, Kristin Langwasser, Ina Drepper and Marcel Förster for excellent research assistance. Correspondence: IIW, University of Bonn Lennéstrasse 37 d-53113 Bonn Germany Emails: alan.ahearne@bruegel.org, birgit.schmitz@uni-bonn.de, vonhagen@uni-bonn.de 1. Introduction The obser