Currency Shocks and Dynamics of Trade Flows in the Euro Area: Evidence from Quarterly and Monthly Data

Abstract

This work examines euro area's trade flows over the last two decades, taking jointly into account their long-run determinants and short-run dynamics. This framework builds on a reinterpretation of the long-run structural vector autoregressive approach, drawing from both economic theory and econometric analysis. Generalized impulse response functions are employed to assess the effects of a real exchange rate shock on the trade balance, using different model specifications and frequencies of data. The main findings are: i) euro-area's trade flows are determined in the long-run by non-price competitiveness factors; ii) short-run adjustments follow an S-pattern; iii) a real devaluation produces detrimental effects on the trade balance.

Keywords: Euro area, trade balance, real exchange rate, long-run structural VAR approach, Subset VECM, impulse response analysis, data frequency

JEL Classification: C32, C52, F32, F41