The productivity slowdown in Southern Europe, particularly in Italy and Spain, has been a major economic issue since the mid-1990s. This paper compares two competing explanations: the neoclassical view, which attributes the slowdown to capital misallocation due to financial integration and lower interest rates, and the post-Keynesian model, which emphasizes the role of exchange rates and foreign trade. Using panel data from the EU KLEMS database, the study finds that the neoclassical hypothesis is less robust, as its results depend heavily on including Italy in the sample. When the nominal effective exchange rate is introduced, the real interest rate effect becomes statistically insignificant, supporting the post-Keynesian explanation. Panel cointegration analysis further confirms that the negative impact of exchange rate appreciation on productivity is robust, indicating that the productivity slowdown in Southern Europe is better explained by exchange rate dynamics rather than capital misallocation. The study concludes that the divergence in productivity between Northern and Southern Euro area countries is primarily due to persistent shocks in the rate of change of the nominal exchange rate, influenced by the adoption of the single currency.The productivity slowdown in Southern Europe, particularly in Italy and Spain, has been a major economic issue since the mid-1990s. This paper compares two competing explanations: the neoclassical view, which attributes the slowdown to capital misallocation due to financial integration and lower interest rates, and the post-Keynesian model, which emphasizes the role of exchange rates and foreign trade. Using panel data from the EU KLEMS database, the study finds that the neoclassical hypothesis is less robust, as its results depend heavily on including Italy in the sample. When the nominal effective exchange rate is introduced, the real interest rate effect becomes statistically insignificant, supporting the post-Keynesian explanation. Panel cointegration analysis further confirms that the negative impact of exchange rate appreciation on productivity is robust, indicating that the productivity slowdown in Southern Europe is better explained by exchange rate dynamics rather than capital misallocation. The study concludes that the divergence in productivity between Northern and Southern Euro area countries is primarily due to persistent shocks in the rate of change of the nominal exchange rate, influenced by the adoption of the single currency.