Working Paper: NBER ID: w16259
Authors: Paul Bergin; Chingyi Lin
Abstract: 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.
Keywords: currency union; trade; European Monetary Union; extensive margin; dynamic stochastic general equilibrium
JEL Codes: F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| extensive margin of trade (F10) | anticipatory response from firms (D84) |
| EMU adoption (F36) | extensive margin of trade (F10) |
| EMU adoption (F36) | overall trade volume (F10) |
| anticipatory response from firms (D84) | extensive margin of trade (F10) |
| expectations about future existence of the union (D84) | welfare gains (D69) |
| reduced iceberg costs (F12) | trade costs (F19) |
| initial effect on overall trade volume (F69) | negative effect on intensive margin (F66) |