Gravity, Scale and Exchange Rates
We develop a structural gravity model that introduces scale effects in bilateral trade. Scale effects and incomplete passthrough give two channels through which exchange rates have real effects on trade patterns. Estimates from Canadian provincial trade data identify these effects through their interaction with the US border. We find statistically and quantitatively significant economies of scale in cross-border trade in almost 2/3 of sectors. Real effects of exchange rate changes on trade are found for 12 of 19 goods sectors and none of 9 services sectors.
Funding provided by Department of Foreign Affairs and International Trade, Canada. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.