Positive OCA Criteria: Microfundations for the Rose Effect

COE/RES Discussion Paper Series No. 34

28 Pages Posted: 15 Oct 2006

See all articles by Richard E. Baldwin

Richard E. Baldwin

University of Geneva - Graduate Institute of International Studies (HEI); Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Daria Taglioni

World Bank, Development Economics

Date Written: February 2004

Abstract

Since Rose (2000), many scholars have found empirical evidence linking trade to exchange rate volatility and currency unions. Our paper takes a first step toward providing theoretical underpinnings for this "Rose effect". In our Melitz-like trade model, reduced volatility boosts trade by inducing existing exporters to export more and by inducing more firms to begin exporting. Specifically, volatility is a greater hindrance to export for small firms, so reduced volatility especially promotes small firms' exports. Because most firms are small, the extra exports induced by a marginal reduction in volatility may increase as the level of volatility falls - a result that can account for the convexity of the trade-volatility link implied by the Rose effect. We derive and test three new empirical hypothesis generated by our model. We find some support for two of them using data on Eurozone aggregate bilateral trade, but have insufficient data to test the third in a convincing manner.

Keywords: OCA, Monetary Union, Heterogeneity, Trade

JEL Classification: F1, F0

Suggested Citation

Baldwin, Richard E. and Taglioni, Daria, Positive OCA Criteria: Microfundations for the Rose Effect (February 2004). COE/RES Discussion Paper Series No. 34, Available at SSRN: https://ssrn.com/abstract=936732 or http://dx.doi.org/10.2139/ssrn.936732

Richard E. Baldwin

University of Geneva - Graduate Institute of International Studies (HEI) ( email )

PO Box 136
Geneva, CH-1211
Switzerland
+41 22 908 5933 (Phone)
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HOME PAGE: http://www.hei.unige.ch/~baldwin/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Daria Taglioni

World Bank, Development Economics ( email )

Washington, DC 20433
United States