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Currency Unions, Trade and Heterogeneity

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  • Natalie Chen
  • Dennis Novy

Abstract

How do trade costs affect international trade? This paper offers a new approach. We rely on a flexible gravity equation that predicts variable trade cost elasticities, both across and within country pairs. We apply this framework to the effect of currency unions on international trade. While we estimate that currency unions are associated with a trade increase of around 38 percent on average, we find substantial underlying heterogeneity. Consistent with the predictions of our framework, we find effects around three times as strong for country pairs associated with small import shares, and a zero effect for large import shares. Our results imply that conventional homogeneous currency union estimates do not provide helpful guidance for countries considering to join a currency union. Instead, countries need to take into account the distribution of their trade shares to assess the impact of trade costs.

Suggested Citation

  • Natalie Chen & Dennis Novy, 2018. "Currency Unions, Trade and Heterogeneity," CEP Discussion Papers dp1550, Centre for Economic Performance, LSE.
  • Handle: RePEc:cep:cepdps:dp1550
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    References listed on IDEAS

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    Cited by:

    1. Felbermayr, Gabriel & Steininger, Marina, 2019. "Revisiting the euro's trade cost and welfare effects," Kiel Working Papers 2121, Kiel Institute for the World Economy (IfW).
    2. Rodolphe Desbordes & Markus Eberhardt, 2019. "Gravity," Discussion Papers 2019-02, University of Nottingham, GEP.

    More about this item

    Keywords

    currency unions; Euro; gravity; heterogeneity; trade costs; trade elasticity; translog;

    JEL classification:

    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • F15 - International Economics - - Trade - - - Economic Integration
    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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