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

a r t i c l e i n f o Keywords: Current account Trade balance vis-à-vis the euro area Trade balance vis-à-vis the rest of the world European monetary union Culture Institutions 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. Despite the fact that the euro area as a whole has been in balance with the rest of the world, many euro area member countries have had substantial current account imbalances. These imbalances had a tendency to grow after the adoption of the common currency in 1999. However, in order to fully understand these imbalances we need to look at how these imbalances have been distributed between balances against the euro area and balances against the rest of the world (see, e.g., Eichengreen (2010)). Thus, we follow the decomposition made in Schmitz and von Hagen (2011) and decompose trade balances into intra balances and extra balances. Intra balance measures the trade balance vis-à-vis the euro area, whereas extra balance measures the trade balance vis-à-vis the rest of the world. In some cases, a country has had a positive intra balance but a negative extra balance, or vice versa (see Figs. 1–2). The Netherlands and Belgium–Luxembourg act as financial intermediaries since there is a net capital flow …