Exchange Rate Volatility, Euro Effect and the Two Margins of Trade: Evidence from Monthly Trade Data

Abstract

The aim of this paper is to provide further empirical evidence on the relation between exchange rate volatility, currency unions and trade. The novelties with respect to previous research are threefold. First, monthly trade and exchange rate data are used to take into account the short term effects of volatility on the bilateral exchange rate. Second, disaggregated trade data are used to deal with differences among industries and between final and intermediate goods. Finally, the existence of zero trade flows is taken into account by distinguishing between the extensive and the intensive margins of trade. Investigating the impact of exchange rate volatility and the Euro at the same time allows us to disentangle the effect of a common currency beyond the elimination of any variation in the exchange rate. Furthermore, the developments of the past years with the financial crisis and the EU enlargement to the East are taken into account, yielding additional findings and policy implications.