Estimating the Impact of Currency Unions on Trade Using a Dynamic Gravity Framework

Campbell, Douglas L. (2012): Estimating the Impact of Currency Unions on Trade Using a Dynamic Gravity Framework.

Abstract

Does leaving a currency union reduce international trade? This paper reexamines time series estimates of currency unions on trade from a historical perspective using a dynamic gravity equation and by conducting in-depth case studies of currency union breakups. The early large estimates are sensitive to dynamic specifications, and were driven by omitted variables, as many breakups were caused by warfare, communist takeovers, coup d'etats and other major geopolitical events. The methodology has general applicability for the use of gravity equations in policy analysis, and yields an imprecise point estimate of currency unions on trade close to one percent.

• Item Type: MPRA Paper
• Language: English
• Keywords: Currency Unions, Trade, Dynamic Gravity, Decolonization
• Subjects: F - International Economics > F1 - Trade > F10 - General; F - International Economics > F3 - International Finance > F33 - International Monetary Arrangements and Institutions; F - International Economics > F5 - International Relations, National Security, and International Political Economy > F54 - Colonialism ; Imperialism ; Postcolonialism

References

Alesina, A., R. J. Barro and S. Tenreyro, “Optimal Currency Areas,” in NBER Macroeconomics Annual 2002, Volume 17 (National Bureau of Economic Research, Inc, 2003), 301–356.

Anderson, J. E., “A Theoretical Foundation for the Gravity Equation,” American Economic Review 93 (1979), 170–192.

Anderson, J. E. and E. van Wincoop, “Gravity with Gravitas: A Solution to the Border Problem,” American Economic Review 93 (2003), 170–192.

Arellano, M. and O. Bover, “Another Look at Instrumental Variables Estimation of Error-Component Models,” Journal of Econometrics 68 (1995), 29–51.

Baldwin, R., “The Euro’s Trade Effect,” European Central Bank, Working Paper No. 594 (2006).

Baldwin, R. and D. Taglioni, “Gravity for Dummies and Dummies for Gravity Equations,” NBER Working Papers 12516, National Bureau of Economic Research, Inc, September 2006.

Baranga, T., “Fixed Exchange Rate Networks and the Effect of Fixed Exchange Rates on Bilateral Trade Flows,” Working Paper (2009).

———, “Estimating the Effects of Fixed Exchange Rates on Trade: Evidence from the Formation of the Euro,” Working Paper (2011).

Barro, R. and S. Tenreyro, “The Economic Effects of Currency Unions,” Economics Inquiry 45 (2007), 1–23.

Berger, H. and V. Nitsch, “Zooming Out: The Trade Effect of the Euro in Historical Perspective,” Journal of International Money and Finance 27 (2008), 1244–1260.

Bergin, P. and C.-Y. Lin, “The Dynamic Effects of a Currency Union on Trade,” Journal of International Economics (2012).

Bertrand, M., E. Duflo and S. Mullainathan, “How Much Should We Trust Differences-in-Differences Estimates?,” The Quarterly Journal of Economics 119 (February 2004), 249–275.

Blundell, R. and S. Bond, “Initial Conditions and Moment Restrictions in Dynamic Panel-Data Models,” Journal of Econometrics 87 (1998), 115–143.

Bomberger, W. A., “Decolonization and Estimates of the Time Series Effect of Currency Unions,” Working Paper, University of Florida (2003).

Bun, M. J. G. and F. J. G. M. Klaassen, “The Euro Effect on Trade is not as Large as Commonly Thought,” Oxford Bulletin of Economics and Statistics 69 (2007), 473–496.

Campbell, D. L., “History, Culture, and Trade: A Dynamic Gravity Approach,” Working Paper (2010).

Chaney, T., “Distorted Gravity: The Intensive and Extensive Margins of International Trade,” American Economic Review 98 (September 2008), 1707–21.

Chen, H., A. Mirestean and C. G. Tsangarides, “Limited Information Bayesian Model Averaging for Dynamic Panels with an Application to a Trade Gravity Model,” (October 2011).

Combes, P.-P., M. Lafourcade and T. Mayer, “The Trade-Creating Effects of Business and Social Networks: Evidence from France,” Journal of International Economics 66 (May 2005), 1–29.

Dorn, S. and P. Egger, “On the Distribution of Exchange Rate Regime Treatment Effects on International Trade,” (November 2011).

Eichengreen, B. and D. A. Irwin, “Trade Blocs, Currency Blocs and the Reorientation of World Trade in the 1930s,” Journal of International Economics 38 (February 1995), 1–24.

———, “The Role of History in Bilateral Trade Flows,” in The Regionalization of the World Economy (National Bureau of Economic Research, Inc, 1998), 33–62.

Escalona, C. R. T. and E. Gomez, “The Euro Effect on Trade: Evidence in Gravity Equations Using Panel Cointegration Techniques,” Working Papers. Serie EC 2011-07, Instituto Valenciano de Investigaciones Economicas, S.A. (Ivie), July 2011.

Esteve-Pérez, S., S. Gil-Pareja, R. Llorca-Vivero and J. A. Martínez-Serrano, “The Impact of the Euro on Firm Export Behaviour: Does Firm Size Matter?,” Oxford Economic Papers 63 (April 2011), 355–374.

Feenstra, R. and H. L. Kee, “Export Variety and Country Productivity: Estimating the Monopolistic Competition Model with Endogenous Productivity,” Journal of International Economics 74 (March 2008), 500–518.

Feenstra, R. C., Advanced International Trade: Theory and Evidence (Princeton University Press, 2003).

Glick, R. and A. K. Rose, “Does a Currency Union Affect Trade? The Time-Series Evidence,” European Economic Review 46 (June 2002), 1125–1151.

Grossman, G. M. and E. Helpman, Innovation and Growth in the Global Economy, volume 1 of MIT Press Books (The MIT Press, 1993).

Havranek, T., “Rose Effect and the Euro: The Magic is Gone,” Technical Report, Review of World Economics 146(2), 241-261., 2010.

Katayama, H. and M. Melatos, “The Nonlinear Impact of Currency Unions on Bilateral Trade,” Economics Letters 112 (July 2011), 94–96.

Kelejian, H., G. S. Tavlas and P. Petroulas, “In the Neighbourhood: the Trade Effects of the Euro in a Spatial Framework,” Working Papers 136, Bank of Greece, August 2011.

Klein, M. W., “Dollarization and Trade,” Journal of International Money and Finance 24 (October 2005), 935–943.

Klein, M. W. and J. C. Shambaugh, “Fixed Exchange Rates and Trade,” Journal of International Economics 70 (December 2006), 359–383.

Krugman, P., “The Narrow Moving Band, the Dutch Disease, and the Competitive Consequences of Mrs. Thatcher: Notes on Trade in the Presence of Dynamic Scale Economies,” Journal of Development Economics 27 (October 1987), 41–55.

Krugman, P. and E. Helpman, Market Structure and International Trade: Increasing Returns, Imperfect Competition, and the International Economy (The Massachusetts Institute of Technology, 1985).

Krugman, P. R., “Increasing Returns, Monopolistic Competition, and International Trade,” Journal of International Economics 9 (November 1979), 469–479.

Lopez-Cordova, J. E. and C. M. Meissner, “Exchange-Rate Regimes and International Trade: Evidence From the Classical Gold Standard Era,” American Economic Review 93 (March 2003), 344–353.

Manuel Agosin, C. B.-O., Roberto Alvarez, “Determinants of Export Diversification Around the World: 1962-2000,” Working Paper, Central Bank of Chile (2011).

Martinez-Zarzoso, I., F. N.-L. D. and N. Horsewood, “Effects of Regional Trade Agreements Using a Static and Dynamic Gravity Equation,” Ibero America Institute for Econ. Research (IAI) Discussion Papers 149, July 2006.

Nickell, S. J., “Biases in Dynamic Models with Fixed Effects,” Econometrica 49 (November 1981), 1417–26.

Nitsch, V., “Currency Union Entries and Trade,” Discussion Papers 2005/9, Free University Berlin, School of Business & Economics, 2005.

Olivero, M. P. and Y. V. Yotov, “Dynamic Gravity: Endogenous Country Size and Asset Accumulation,” Working Paper (2010).

Persson, T., “Currency Unions and Trade: How Large is the Treatment Effect?,” Economic Policy 16 (October 2001), 433–462.

Qureshi, M. S. and C. G. Tsangarides, “The Empirics of Exchange Rate Regimes and Trade: Words vs. Deeds,” IMF Working Papers 10/48, International Monetary Fund, February 2010.

———, “Exchange Rate Regimes and Trade: Is Africa Different?,” Technical Report, 2011.

Ritschl, A. O. and N. Wolf, “Endogeneity of Currency Areas and Trade Blocs: Evidence from a Natural Experiment,” Kyklos 64 (05 2011), 291–312.

Rose, A. K., “One Money, One Market: The Effect of Common Currencies on Trade,” Economic Policy 15 (2000), 7–46.

———, “Currency Unions and Trade: The Effect is Large,” Economic Policy 16 (October 2001), 449–461.

Sadikov, A. M., L. Zeng, P. B. Clark, S.-J. Wei and N. T. Tamirisa, “A New Look at Exchange Rate Volatility and Trade Flows,” IMF Occasional Papers 235, International Monetary Fund, September 2004.

Thom, R. and B. Walsh, “The Effect of a Currency Union on Trade: Lessons from the Irish Experience,” European Economic Review 46 (June 2002), 1111–1123.