The Dynamic Effects of Currency Union on Trade
A currency union's ability to increase international trade is one of the most debated questions in international macroeconomics. This paper studies the dynamics of these trade effects. First, an empirical study of the European Monetary Union finds that the extensive margin of trade (entry of new firms or goods) responds several years ahead of overall trade volume. This implies that the intensive margin (previously traded goods) falls in the run-up to EMU. The paper's theoretical contribution is to study the announcement of a future monetary union as a news shock to trade costs in the context of a dynamic stochastic general equilibrium trade model. Early entry of new firms in anticipation is explainable as a rational forward-looking response under certain conditions, where essential elements include sunk costs of exporting and heterogeneity among firms of a type known before entry. The findings help identify which types of trading frictions are reduced by a currency union. The important role of expectations also indicates that continued gains from EMU depend upon long-term credibility of the union.
We thank for comments: James Anderson, Jeffrey Bergstrand, Caroline Freund, Keith Head, Thomas Lubik, Christopher Meissner, Dennis Novy, Wing-Leong Teo, and participants of the Warwick Trade Cost conference in Venice 2010 and the DSGE Conference in National Taiwan University 2010. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Bergin, Paul R. & Lin, Ching-Yi, 2012. "The dynamic effects of a currency union on trade," Journal of International Economics, Elsevier, vol. 87(2), pages 191-204. citation courtesy of