Macroeconomic determinants of international trade.

• Author: Rose, Andrew K.
• Position: Research Summaries

Introduction

Much research on international trade patterns focuses on deep primitive causes of trade, such as differences in national factor endowments, preferences, or technologies. In much of my recent research in the area, I examine less traditional causes of trade flows. In particular, I've tended to focus mostly on the macroeconomic determinants and consequences of trade.

How much does Monetary Union Stimulate Trade?

A number of countries in the Americas and Europe have engaged in monetary unions of late. This is usually to the chagrin of academic economists who point out that joining a monetary union means giving up the tool of independent monetary policy that can be used to smooth idiosyncratic business cycles. This cost seems high, and there are others. Where are the benefits of currency union?

Perhaps currency union brings the benefit of higher international trade within the union. If there's a single issue that economists agree on, it's that trade should be as free and unfettered as possible. And, two countries with different monies are separated by a monetary barrier to trade, otherwise known as the exchange rate. That barrier might be small if exchange rate costs are small or easy to hedge; but the barrier might be large. After all, the one thing we know about exchange rates is that they tend to change, usually in unpredictable ways. Quantifying the impact of currency unions and exchange rate uncertainty on trade is thus an empirical exercise of importance.

In a 1999 paper I quantified the impact of currency union on trade and found it to be remarkably large. (1) In particular, I estimated that two countries sharing a common currency will trade over three times as much as an otherwise comparable pair of countries, holding other things equal. This effect is large--implausibly large-but my extensive sensitivity analysis simply couldn't reduce it substantially.

My research was based on a model that I have tended to use quite a bit for much of my work in international trade: the bilateral "gravity" model of trade. The gravity model has enjoyed a resurgence of use in the last decade, because it has solid theoretical foundations and turns in an admirable empirical performance. Stripped to its essence, the gravity model states that trade between a pair of countries is inversely proportional to the distance between them, and is proportional to their combined economic mass (usually proxied by GDP). (2) The model fits the data well and produces plausible coefficient estimates that tend to be similar across different studies and authors, an unusual combination in economics.

One of the issues with the gravity model is that it is intrinsically cross-sectional, relying on variation across pairs of countries. That's a disadvantage for inherently time-series questions such as: "what is the effect on trade of leaving or joining a currency union?" To address such important questions, Reuven Glick and I gathered a dataset covering over 200 countries and 50 years. (3) This enabled us to use a variety of conventional panel data techniques, including the "fixed-effects" estimator that uses only time-series variation within a pair of countries. We found that the impact of leaving...