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Introduction: The status of the Rose finding and of the first trade effects of the euro
To be discussed: 1. Roses (2000) famous gravity-model estimate: monetary unions triple trade among members. 2. Critiques of Rose 3. First post-1999 results on effects of the on European trade patterns. 4. The key question: what explains the smaller effects of the to date relative to historical estimates
1. Country size? 2. Gradual adjustment over time? 3. Spuriously high previous estimates?
5.
Probably the most influential empirical paper in the field in the last decade The research was motivated by the coming EMU, but estimates were based on historical data from much smaller countries. Findings
MU => tripling of trade among members Fixed exchange rate in itself also => statistically significant increase in trade
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and Critique of the critiques, e.g., response by Frankel (2006) 1) Small-country results may not apply to large countries.
Response: There has been no evidence of MU effect varying with size.
2/
Critiques,
continued
2. Gross magnitudes
Tripling seems too large to be believable. Van Wincoop critique: Re-parameterizing the gravity-based estimate to fit a theoretical model cuts the magnitude of the MU estimate below x3. 1/
Response -
Statistically significant On the same order of magnitude as the estimated effects of FTA, and as the estimated effects of borders (home bias), e.g., Canada-US 2/ Greater than thought 10 years ago.
1/ Rose & van Wincoop (2001): trade barriers are halved when joining MU. => trade >50%. 2/ McCallum (1995), Helliwell (1998), Wei (1996), and Nitsch (1990, 1991)
Critiques,
continued
But endogeneity remains a likely problem: What if the observed correlation arises because pairs that trade for each other (for reasons not captured by controls) decide to link currencies on Optimum Currency Area grounds?
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Critiques,
concluded
Micco, Ordonez & Stein (2003): for pairs of the 1st 12 EMU joiners, trade rose significantly. 15 % beyond what could be explained by growth, etc. a range of 6 - 26 % (depending on dummies), with a larger set of 22 industrialized countries. Preferred estimates (with pair dummies): 4 -16%.
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1/ e.g., Frankel-Rose, 2002 2/ Begg, et al (2003), Micco, Stein & Ordoez (2003), and Flam
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Moreover, possible endogeneity is still with us The decision to join the , by Slovenias or Irelands, could be misleadingly correlated with shift in trade pattern toward continental Europe, either because:
such a shift is a political goal, encouraged by
other means as well, or
trade is shifting direction for natural economic reasons, and policy-makers want to reduce fx costs
for importers & exporters.
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Table 1 --
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16
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Table 2 --
Effect becomes significant in 1999 Reaches 16% in 2001 Steady through 2006
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Do the effects of monetary union diminish with the size of the countries involved?
Add an interactive size term -- the product of the respective country sizes and the CU dummy variable - to see whether CU effects on trade are bigger for small countries than for large countries, so that this might explain the smaller effect in Europe. Larger countries do not experience smaller boosts to intra-MU trade to a statistically significant extent. The effect of EMU on bilateral trade remains, even after controlling for size.
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Mystery: If neither time lags nor size explain the gap between 15% and doubling, then what does?
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In cross-section, EMU is estimated to increase intra-member trade by 2-3 times, but only when entire data sample is used
The Effect of EMU on Trade: Different Estimators and Samples, 1948-2006
200%
180%
160%
140%
120%
100%
80%
60%
40%
20%
0% Full Sample Fixed Effects Full Sample OLS Developed Sample Developed Sample Fixed Effects OLS EU Sample Fixed Effects EU Sample OLS
-20%
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We proceed step-by-step from our reproduction of M-O-S, to see at which stage the coefficients change
Table 6 expands the dataset to 1948-2006, a panel with almost 60 years of data, while retaining a separate coefficient to distinguish EMU from others. The graph reveals that sample size is the crucial difference between MSO & broader estimates. While estimates of the euros effect on trade continue to linger around 10-25% for the developed & EU samples that MSO used, they climb dramatically to .9-1.0 for the full sample exponentially = 2.5-2.7, almost tripling. Estimates are highly significant, because there are more data to work with now.
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6-10 years after monetary union, estimated effects on trade from other MUs are virtually the same as from EMU, provided estimation is on full sample of countries/years (1948-2006)
The Effect of Non-EMU Currency Unions and of EMU on Bilateral Trade over Time: Fixed Effects Estimators
700%
600%
500%
400%
300%
200%
100%
0% 1 Yr Prior to NonEMU CU 1 Yr Prior to EMU 1-5 Yrs Post NonEMU CU 1-5 Yrs Post EMU 6-10 Yrs Post NonEMU CU 6-10 Yrs Post EMU 11-15 Yrs Post NonEMU CU 16-20 Yrs Post NonEMU CU 21-25 Yrs Post NonEMU CU 26-30 Yrs Post NonEMU CU
-100%
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Mystery solved?
We have uncovered the possibility that the large gap is an artifact of the largely non-overlapping historical periods analyzed in the Rose & M-O-S studies
(pre- & post-1999, respectively).
Perhaps some parameters such as common border and common language dummies are not estimated well enough on smaller samples, affecting estimates of -area coefficient. Estimated trade effects of as great as trade effects of non-EMU CUs. Moreover, the estimated coefficient of EMU > coefficient for EU or other FTAs !
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But could all estimates of CU effects be biased upwards due to endogeneity of the currency decision?
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A natural experiment:
The effects of the French francs conversion to on bilateral trade of African CFA members.
The long-time link of CFA currencies to the F franc has clearly always had a political motivation.
So CFA trade with France could not reliably be attributed to currency link,
perhaps even after controlling for common language, former colonial status, etc.
But in Jan. 1999, 14 CFA countries suddenly found themselves with the same currency link to Germany, Austria, Finland, Portugal, etc.
No economic/political motivation. A natural experiment. If CFA trade with these other countries has risen, that suggests a effect that we can declare causal.
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Conclusions
1. Update of first estimates of effect of on intra-EMU trade shows the coefficient in 2003-2006 remained significant and steady at the level attained in 2001-02. 2. But it didnt continue to rise. No evidence that lags explain the big gap between effect of (15%) and earlier estimates of effects of other Monetary Unions (x2 or x3) 3. There is also no evidence that the gap is explained by a MU effect that diminishes with country size. 4. The natural experiment of the CFA suggests that the high estimates of effects among small or poor countries have not resulted from endogeneity of currency decisions. 5. Solution to the mystery?
1. Apparently the additional data from the full data set is necessary for accurate estimates of the parameters. 2. Perhaps the effect is as large as effects of other MUs after all; 3. but the mystery is not yet completely solved.
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References
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