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The Dynamic Effects of Currency Union on Trade

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  • Ching-Yi Lin

    (Tsinghua University, Taiwan)

  • Paul Bergin

    (University of California at Davis)

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. As empirical motivation, we find that the extensive margin of trade (entry of new firms or goods) in the eurozone responded several years prior to implementation of the European monetary union. The paper studies the announcement of a future monetary union as a news shock to trade costs in the context of a two-country dynamic stochastic general equilibrium model. We study the conditions under which one should see entry of new firms in anticipation of the new regime; we find that this requires both sunk costs of exporting and heterogeneity among firms of a type that is known before the sunk cost is paid. Without this firm heterogeneity, the expectation for entry by other firms in future periods eliminates the expected future profits needed to motivate early entry in periods of lower profits prior to the new policy regime. A conventional model of learning by doing will not generate this result. The important role of expectations also indicates that continued gains from EMU depend upon long-term credibility of the monetary union, a finding with significant consequences given recent events in Europe. The findings also help identify which types of trading frictions are reduced by a currency union.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 291.

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Date of creation: 2011
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Handle: RePEc:red:sed011:291

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References

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Citations

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Cited by:
  1. Kemal Türkcan, 2014. "Investigating the Role of Extensive Margin, Intensive Margin, Price and Quantity Components on Turkey’s Export Growth during 1998-2011," Working Papers 2014/2, Turkish Economic Association.
  2. Douglas L. Campbell, 2013. "Relative Prices, Hysteresis, and the Decline of American Manufacturing," 2013 Papers pca584, Job Market Papers.
  3. Campbell, Douglas L., 2011. "Estimating the impact of currency unions on trade using a dynamic gravity framework," MPRA Paper 35531, University Library of Munich, Germany.
  4. Mario Larch & Wolfgang Lechthaler, 2013. "Whom to send to Doha? The Short-sighted Ones!," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 16(4), pages 634-649, October.
  5. Moser, Christoph & Rose, Andrew K., 2014. "Who benefits from regional trade agreements? The view from the stock market," European Economic Review, Elsevier, vol. 68(C), pages 31-47.
  6. Auray, Stéphane & Eyquem, Aurélien & Poutineau, Jean-Christophe, 2012. "The effect of a common currency on the volatility of the extensive margin of trade," Journal of International Money and Finance, Elsevier, vol. 31(5), pages 1156-1179.
  7. Douglas L. Campbell, 2013. "Estimating the Impact of Currency Unions on Trade: Solving the Glick and Rose Puzzle," The World Economy, Wiley Blackwell, vol. 36(10), pages 1278-1293, October.
  8. Florian Mölders, 2012. "On the Path to Trade Liberalization: Political Regimes in International Trade Negotiations," Discussion Papers of DIW Berlin 1245, DIW Berlin, German Institute for Economic Research.
  9. Cavallari, Lilia & D'Addona, Stefano, 2013. "Trade margins and exchange rate regimes: new evidence from a panel VAR," MPRA Paper 51585, University Library of Munich, Germany.
  10. Türkcan, Kemal, 2014. "Exports Margins in Austria’s Export Growth," MPRA Paper 53085, University Library of Munich, Germany.
  11. Paul Bergin & Ling Feng & Ching-Yi Lin, 2014. "Financial Frictions and Firm Dynamics," NBER Working Papers 20099, National Bureau of Economic Research, Inc.

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