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Currency Unions and Trade: A Post-EMU Reassessment

This paper reassesses the effect of currency unions on trade, focusing on the European Monetary Union (EMU) and comparing it to other currency unions. It examines the symmetry between currency union exit and entry and explores the impact of advances in methodology.

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Currency Unions and Trade: A Post-EMU Reassessment

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  1. Currency Unions and Trade:A Post-EMU Reassessment Reuven Glick Federal Reserve Bank of San Francisco Andrew K. Rose UC Berkeley-Haas, CEPR, NBER Disclaimer: Any opinions expressed here do not necessarily reflect the views of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System

  2. Motivation • Glick-Rose (2002) used panel approach to investigate effect of currency unions on trade, using data for 1948-1997 before establishment of EMU • Found currency unions increase trade by ~90% • Current paper uses data for 1948-2013 and asks • Is EMU similar to other currency unions? • Is there symmetry between currency union exit and entry? • Assumed symmetry before. Couldn’t test because had only 16 entries, 130 exits in 1948-1997 sample • Can test now with EMU entries • Do advances in methodology matter?

  3. Examples of Currency Unions • Multilateral Currency Unions • European Monetary Union (1999-) • CFA Franc Zone • Eastern Caribbean Currency Union • Common (Rand) Monetary Area • Anchor Currency Unions • British £: Bahamas (-1965), NZ (-1966), India (-1966), Ireland (-1978) …. • US $: Panama, Bahamas (1966-), Ecuador (2000-), El Salvador (2001-), Zimbabwe (2009-) Argentina (1991-2001) …. • Fr Franc: Morocco (-1957), Algeria (-1968) …

  4. Costs and Benefits of Joining a Monetary Union Costs • Loss of nominal exchange rate as policy tool • Loss of national monetary policy control Benefits • Greater transparency of prices encourages greater competition and efficiency • Reduced currency risk encourages more trade and investment

  5. Debate in Literature on Magnitude of Trade Effect of CUs • It’s big, 90-100%. • e.g. Glick and Rose (2002), Frankel (2010) • It’s moderate, 40-50% • e.g. Eicher and Henn (2011) • It’s small for the EMU, 0-20% • e.g. Micco et al (2003), Bun and Klaasen (2002, 2007), de Nardis and Vicarelli (2003), Flam and Nordstrom (2007), Berger and Nitsch (2008), Camarero et al (2013) • EMU effect might even be negative • e.g. Baldwin and Taglioni (2007)

  6. Preview of Findings • EMU different from other CUs, increases trade among EMU countries by ~50% • Find symmetry • Econometric methodology matters a lot • Sample matters a lot as well

  7. Measuring Trade Effects“Old” Methodology: Gravity Equation ln(Tradeijt) = CUijt + Zijt+ {δt} +ijt • Tradeijt = average nominal value of bilateral trade between i and j at time t, • CU = 1 if i and j use the same currency at time t and 0 otherwise, • Z = gravity control variables, usual suspects: e.g. GDP, distance, common language, border, regional RTA, colonial history, etc. … • {δt} = year-specific effects

  8. Methodological Issues in Estimating • Omitted variables • Effects of CU between i and j on other countries through “multilateral resistance” effects • General equilibrium effects on spending and output for all countries • Homogeneity implicit in treating all currency unions alike

  9. Data Set • IMF DoTS trade: >200 “countries” 1948-2013 (with gaps) • Population, real GDP: WDI > PWT > IFS • Country Characteristics: World Factbook • Regional Trade Agreements (RTAs): WTO • Currency Unions: Glick-Rose updated • 1:1 par for extended period of time (not just hard fixes) • Transitive: x-y and y-z imply x-z

  10. Why We Want a Large Data Set A large data set – spanning both countries and time -- • Provides many degrees of freedom • Allows direct comparison of effects of individual CUs, such as EMU, with others. Report results • Combining all CUs into a single variable • Disaggregating into EMU and all other CUs • Breaking out effects of non-EMU CUs separately

  11. Gravity Estimates for Trade e1.3 ~3.7x e.92 ~2.5x nil Note: Pooled OLS estimates. Other gravity regressors and year dummies included, but not reported. Robust standard errors in parentheses.

  12. Prefer (Within) Fixed Pair Effect Estimator • Exploits variation over time, answers the policy question of interest, i.e. the (time series) question • “What is the trade effect of a country joining (or leaving) a currency union?” • Controls for unobserved pair effects, including potential endogeneity of currency union

  13. Gravity  Estimates for Trade with Pair Fixed Effects e.41 -1 ~ 51% Note: Pooled OLS estimates. Other gravity regressors and year dummies included, but not reported. Robust standard errors in parentheses.

  14. Measuring Trade Effects Newer (Export) Gravity Models • Much work on “theory-consistent” gravity estimation • Use Least Squares with time-varying country Dummy Variables (LSDV) to control for multilateral resistance and other general equilibrium effects: ln(Exportsijt) = CUijt + Zijt+ {λit} + {ψjt} + ijt • Xijt= nominal value of bilateral exports from i to j at time t, • {λit} = set oftime-varyingexporter dummy variables, • {ψjt} = set of time-varying importer dummy variables

  15. Gravity Estimates for Exportswith country-year effects for exporter & importer Implausible!!! Note: Other gravity regressors and year dummies included, but not reported. Robust standard errors in parentheses.

  16. Gravity  Estimates for Exportswith country-year effects for exporter & importer& country pair FE e.43 -1 ~ 54% Note: Other gravity regressors and year dummies included, but not reported. Robust standard errors in parentheses.

  17. Allow for Dynamic Effects • Add (14) leads and lags around currency union exit/entry • i.e. Add ΣkθkCUENTRYijt-k + ΣkφkCUEXITijt-k to gravity equation • Distinguish effects between EMU/non-EMU exit and entries • Estimate with pair FE • Test for Symmetry (post-entry = - post-exit) • Find symmetry holds well

  18. Allowing Dynamic Effects, CU exit lowers exports, entry raises exports Figure 2

  19. Symmetry Tests, Exports with country-year and pair FE Can’t reject Can’t reject Table reports F-test statistic for Ho of identical slopes ΣkθkΣkφk for given CU pairs and time periods

  20. Sensitivity Analysis of  Estimates : Dis-aggregating Other CUs Note: Other gravity regressors, country-year and pair dummies included, but not reported. 879,794 annual observations, 1948-2013.

  21. Sensitivity Analysisof  EMU Estimates: Varying Country and Sample Period Note: dependent variable is log exports. Other gravity regressors, country-year and pair dummies included, but not reported. Robust standard errors in parentheses; no. of obs. in brackets.

  22. Summary • Glick-Rose (2002) concluded “a pair of countries which joined/left a currency union experienced a near-doubling/halving of bilateral trade.” • Based on: • Assumption of symmetry between currency union exits and entries • Caveat: EMU might be different from other currency unions • Our results insensitive to precise econometric methodology • Here, re-estimate using variety of models, annual panel >200 countries, 1948-2013, 15 EMU years

  23. Conclusions • Methodology and sample matter • Preferred methodology is panel with country-pair fixed effects • Preferred sample includes all countries • Symmetry holds between currency union entry and exits • EMU is different • EMU boosts trade by 50% • Other currency unions have different effects on trade

  24. Future Research • Handling zero and missing trade observations • LS estimates may be biased because of: • Heteroskedasticity, and/or • Discarded observations of zero/missing trade • Santos Silva and Tenreyro propose Poisson pseudo-maximum likelihood to handle both • But difficult to use in big panels like ours • Interaction of effects of joining CUs and other forms of economic integration, such as regional trade arrangements • Many countries joined EMU in years prior to joined EMU

  25. Sensitivity AnalysisRole of Regional Trade Agreements, like EU? • Joining regional trade agreement also affects trade • Many countries joined EU in years prior to when joined EMU, e.g. 2004 “Enlargement” • What’s interaction of EU and EMU membership?

  26. Chronology of Membership in EU and EMU New Members Old Members

  27. Sensitivity Analysis of  and RTA Estimates: Disaggregating EMU and EU effects Note: Other gravity regressors included, but not reported Note: Other gravity regressors included, but not reported

  28. Regional Trade Agreements Matter • Regional trade agreements also have very significant effect on trade • EU has a larger effect than other RTAs • EU entry gains are particularly strong for new members • There are still siginificant gains to joining EMU • Caution: only have short-time sample of EMU experience for newer (e.g. 2007-) members

  29. End

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