Modelling the trade balance between the northern and southern eurozone using an intertemporal approach

We use an intertemporal model to examine the division of the Eurozone area into countries with persistent trade account surpluses and those with persistent deficits. This is done by examining the trade account balances between a Northern group of countries that are in persistent trade account surplus and a Southern group of countries that have persistent deficits over the period 2001–2018. The theoretical model highlights the interaction of consumption, portfolio optimization between holdings of domestic and foreign bonds, fiscal balances, changes in the demand to hold money balances and changes in the pricing of risk in financial markets as reflected in changes in the interest rate differentials. We test the model using both the ARDL and Fully Modified OLS methodologies and find that it performs well empirically with relevant coefficients being both right signed and significant.