Trade imbalances within the euro area and with respect to the rest of the world

- This paper investigates the determinants of trade balances for the EU-15 countries.
- We distinguish between balances against the Eurozone and the rest of the world.
- Some core EMU countries act as financial intermediaries for the periphery countries.
- Our decomposition enables us to understand this phenomenon.
- We find no evidence of increased elasticity of net capital flows to GDP per capita.

Many studies have explored the determinants of current account balances in Europe. However, only in a few studies has trade balance been decomposed into intra balance, trade balance vis-à-vis the euro area, and extra balance, trade balance vis-à-vis the rest of the world. This decomposition is necessary for us to understand why some core euro area countries are acting as financial intermediaries for the periphery countries. Furthermore, the determinants of intra and extra balances might be different because nominal exchange rate cannot adjust between the EMU countries while their financial markets are highly integrated. Thus, we apply this decomposition and supplement the previous studies by including a larger set of theoretically plausible explanatory variables, which is derived from the current account literature. Our contribution is twofold: We observe that, contrary to Schmitz and von Hagen (2011), the introduction of a common currency has not increased the elasticity of net capital flows to per capita incomes within the euro area for the member countries. On the other hand, there is a great heterogeneity among the usual determinants of trade balances whether those contribute to intra balances or extra balances. These results increase our understanding of the imbalances in the euro area.