How To Understand The Theory Of The Euro Zone

Transcription

1 WORKING AER ERIE NO. 53 / OCTOBER 5 INTRA- AND EXTRA-EURO AR IORT DND FOR ANUFACTURE by Robert Anderton Bad H. Batag Frauke kudeny and Nuno ousa

2 WORKING AER ERIE NO. 53 / OCTOBER 5 INTRA- AND EXTRA-EURO AR IORT DND FOR ANUFACTURE Robert Anderton Bad H. Batag 3 Frauke kudeny 4 and Nuno ousa 5 In 5 a pubcatons feature a motf taken from the 5 banknote. Ths paper can be donoaded thout charge from or from the oca cence Research Netork eectronc brary at The ves expressed n ths paper are those of the authors and do not necessary represent those of the European Centra Bank. Batag oud ke to thank the European Unon Center at Texas A& Unversty for ts trave support.we oud ke to thank the Edtora Board of the Workng aper eres as e as an anonymous referee for ther very usefu comments. European Centra Bank and peca rofessor at choo of Economcs Unversty of Nottngham Unversty ark Nottngham NG7 RD Unted Kngdom; e-ma: Robert.Anderton@ecb.nt 3 Department of Economcs Center for ocy Research 46 Eggers Ha yracuse Unversty yracuse Ne York 344- UA; phone (35) fax (35) e-ma: bbatag@maxe.syr.edu 4 Drectorate Economc Deveopments European Centra Bank Kaserstrasse 9 63 Frankfurt am an Germany; e-ma: Frauke.kudeny@ecb.nt 5 European Commsson.

3 European Centra Bank 5 Address Kaserstrasse 9 63 Frankfurt am an Germany osta address ostfach Frankfurt am an Germany Teephone Internet Fax Teex 4 44 ecb d A rghts reserved. Any reproducton pubcaton and reprnt n the form of a dfferent pubcaton hether prnted or produced eectroncay n hoe or n part s permtted ony th the expct rtten authorsaton of the or the author(s). The ves expressed n ths paper do not necessary refect those of the European Centra Bank. The statement of purpose for the Workng aper eres s avaabe from the ebste IN 56-8 (prnt) IN (onne)

4 CONTENT Abstract 4 Non-technca summary 5 Introducton 7 Intra- and extra-euro area mports: mechansms and stysed facts 7 Theoretca foundatons of the mode 3 The estmated mode 4 4 Emprca resuts 9 5 Concudng remarks 4 6 References 6 Appendx A: Theoretca foundatons of the mode 9 Appendx B: Data defntons and sources 3 European Centra Bank orkng paper seres 33 Workng aper eres No. 53 October 5 3

5 Abstract The am of ths paper s to mprove our understandng of the key determnants of ntra- and extra-euro area mports. Usng a smutaneous equaton estmaton frameork and poong the data across nne euro area countres as an approxmaton of the euro area e estmate ntra- and extra-euro area mport demand functons and mpose varous restrctons thn and across equatons. We fnd that there are sgnfcant substtuton effects beteen ntra- and extra-euro area mports due to changes n ther reatve prces he exchange rate voatty decreases trade vs-à-vs regons charactersed by voatty and eads to substtuton of trade aay from hgher-voatty regons toards oer-voatty regons. Keyords: ntra- and extra-euro area mports substtuton trade ntegraton three stage east squares. JEL Cassfcaton: F F5. 4 Workng aper eres No. 53 October 5

6 Non-technca summary Ths paper anayses the behavour of ntra and extra-euro area mports of manufactured goods. The man objectve s to mprove our understandng of the key determnants of ntra and extraeuro area mports and to dentfy the varous reatonshps beteen the to varabes. One contrbuton of ths paper s the anayss of the possbe substtuton effects beteen ntra- and extra-euro area trade fos due to changes n reatve prces and exchange rate voatty thn a frameork of a system of equatons. Our estmaton resuts are based on the perod 989- usng quartery data for ntra- and extra-euro area mport voumes and prces of manufactured goods for nne euro area countres as an approxmaton of the euro area (Begum-Luxembourg France Germany Ireand Itay the Netherands ortuga and pan). Ths perod ncudes varous poces hch shoud further enhance European economc ntegraton and encourage ntra-euro area trade. For exampe the mpementaton of the nge arket rogramme shoud have fostered further European economc ntegraton. oreover the sem-fxed exchange rates of the European Exchange Rate echansm - fooed by onetary Unon and the aunch of the euro n may have been a catayst for groth n ntra-area trade by for exampe reducng exchange rate voatty. What are the stysed facts regardng extra and ntra-euro area mports of manufactures and ther evouton over tme? Frst ntra- and extra-euro area mports are approxmatey equa n magntude - th each accountng for roughy haf of tota euro area mports of manufactures - he manufactures account for around three-quarters of mports of goods for both ntra- and extra-euro area mports. econd n genera mport voumes of manufactures rose sgnfcanty over the sampe perod th extra-euro area mports generay grong more rapdy than ntraeuro area mports. Athough ths resuted n a decne n the rato of ntra-area mports of manufactures reatve to extra-area mports over most of the sampe perod there are some sgns that the rato stopped decnng after the aunch of the euro n 999. In many respects t s not surprsng that extra-euro area mport voumes of manufactures gre at a faster rate than ntra-area mports over most of the sampe perod and may smpy refect the fact that the rapd pace of ord trade ntegraton deveoped more rapdy than EU ntegraton. Ths may be party due to the fact that more and more countres are appearng as Workng aper eres No. 53 October 5 5

7 ne entrants n ord export markets as compettors thereby provdng an ever ncreasng number of varetes of products hch tsef stmuates trade. oreover many of the ne compettors and market entrants are from emergng market economes charactersed by qute dverse comparatve advantages n terms of natura resources and age and sk eves. By contrast the euro area represents a sma number of fary homogeneous countres hose economes are aready hghy ntegrated here more mted dfferences n comparatve advantage have aready been expoted to a sgnfcant degree. In genera our am s to dsentange the separate mpacts of the varous factors drvng ntra and extra-euro area mports - such as changes n reatve prces demand and exchange rate voatty - n order to mprove our understandng of ntra and extra-euro area trade and to dentfy the possbe reatonshps beteen the to varabes. For ths purpose e derve a theoretca mode for an mportng frm based n the euro area hch can purchase ts nputs from the home market from the euro area or from outsde the euro area. The theoretca mode tes us that the frm s choce of mport supper argey depends on the dfferent prces and degrees of exchange rate voatty assocated th the dfferent ocatons of the varous suppers. One nterestng fndng of our emprca ork s that ntra-area mports seem to be charactersed by a greater degree of stabty n comparson to extra-area trade (as suggested by a reatvey hgher estmated parameter for the agged dependent varabe hch suggests a hgher degree of persstence). We aso fnd that there are sgnfcant substtuton effects beteen ntra- and extraeuro area mports due to changes n ther reatve prces he exchange rate voatty depresses trade vs-à-vs regons charactersed by voatty and eads to substtuton of trade aay from hgher-voatty regons toards oer-voatty regons. Accordngy the emnaton of ntra-euro area exchange rate voatty due to the formaton of the euro shoud n the ong-run ncrease ntra-area mports by gettng rd of the trade depressng mpact of voatty and by resutng n some substtuton toards ntra-euro area mports and aay from extra-area mports. 6 Workng aper eres No. 53 October 5

8 Introducton Ths paper anayses the behavour of ntra and extra-euro area mports of manufactured goods. The man objectve s to mprove our understandng of the key determnants of ntra and extraeuro area mports and to dentfy the varous reatonshps beteen the to varabes. A key contrbuton of ths paper s the anayss of the possbe substtuton effects beteen ntra- and extra-euro area trade fos due to changes n reatve prces and exchange rate voatty thn a frameork of a system of equatons. We derve a theoretca mode hch captures the factors hch determne mports as e as the potenta nteractons beteen ntra and extra-euro area mports such as substtuton effects arsng from dfferent degrees of exchange rate voatty or movements n reatve prces etc. The emprca anayss uses batera mport data voumes vaues and unt vaue ndces and provdes estmates of ntra and extra-area mport functons by poong the data across both the ndvdua euro area countres and ther tradng partner countres. eparate ntra- and extra-area mport voume reatonshps are estmated thn a smutaneous estmaton frameork n order to examne the reatonshps beteen ntra and extra-area mports. Three tage Least quares estmaton s used to take advantage of the effcency gans assocated th the possbe correaton of dsturbances across equatons. Ths smutaneous estmaton frameork has the added advantage of aong varous cross-equaton constrants to be mposed and tested. ecton gves a descrpton of some stysed facts concernng ntra and extra-euro area trade and takes us through some mechansms hch may nfuence ntra and extra trade. ecton expans our theoretca mode of mport demand hch forms the bass for our econometrc specfcatons he ectons 3 and 4 gve the estmated mode and the emprca resuts. One possbty for future research s to extend the sampe perod n order to cover the fu perod snce the aunch of the euro thereby aong the mode to be used to evauate the mpact of EU on ntra- and extra-euro area trade.. Intra- and extra-euro area mports: mechansms and stysed facts Our estmaton resuts are based on 48 quarters spannng the perod (989-). Ths perod ncudes varous poces hch shoud further enhance European economc ntegraton and Workng aper eres No. 53 October 5 7

9 encourage ntra-trade. For exampe the mpementaton of the nge arket rogramme shoud have fostered further European economc ntegraton. oreover the sem-fxed exchange rates of the European Exchange Rate echansm - fooed by onetary Unon and the aunch of the euro n may have been a catayst for groth n ntra-area trade by reducng exchange rate voatty. The nge arket rogramme amed at removng a remanng barrers to the free crcuaton of goods servces peope and capta n order to acheve further gans from ntegraton. Regardng trade n goods measures ere taken to emnate non-tarff barrers and other mpedments to trade such as dfferences n technca standards as e admnstratve costs reated to border contros and any natona bases n government procurement. These measures ere expected to promote ntra-ec trade as they decrease the costs of ntra-european exports as e as promotng the substtutabty of European goods due to the harmonsaton of technca standards. The Exchange Rate echansm resuted n a consderabe reducton n exchange rate voatty among European countres hch n turn as expected to promote ntra EC-trade (see European Commsson 99). Regardng the genera queston as to hether exchange rate voatty affects trade ony a fe tme seres studes fnd a sgnfcant mpact of exchange rate uncertanty on trade th the effect beng very sma (eg Koray and Lastrapes 989; Béanger and Guterrez 988; Bn-magh 99; Kenen and Rodrk 986; and ekkat 998). eanhe cross sectona studes such as Hooper and Kohhagen (978) De Graue (987) Brada and éndez (988) De Graue and Verfae (988) avvdes (99) Franke and We (993) apr ekkat and Weber (994) and Echengreen and Irn (995) fnd more evdence of a negatve effect of exchange rate uncertanty but agan ths effect s n most cases reatvey sma. kudeny () hoever argues that studes based on pane data ke Abrams (98) Thursby and Thursby (987) De'Arcca (998) ugh et a. (999) De Graue and kudeny () Rose () and Anderton and kudeny () a fnd negatve and sgnfcant effects for ther proxy of exchange rate uncertanty. In the majorty of these studes the trade oss through exchange rate uncertanty s qute substanta. For exampe De Arcca (998) fnds that the trade gans resutng from the emnaton of exchange rate voatty coud be beteen and 3 percent. eanhe kudeny and Anderton () estmate extra-euro area mport functons and fnd that exchange rate voatty may have reduced extra-euro area mports by around %. 8 Workng aper eres No. 53 October 5

10 The evdence regardng ntra-european trade seems to support the noton that reductons n exchange rate voatty have a postve mpact on trade. De Graue and Verfae (988) sho that athough the E decreased exchange rate voatty among ts members groth n trade beteen member countres of the European Communty remaned so beteen (soer than trade groth th the rest of the ord). Hoever once factors such as the genera economc sodon n the EC at the tme are taken nto account De Graue and Verfae fnd that the reducton n exchange rate voatty had a postve effect on ntra-ec trade. tokman (995) carred out a sectora anayss of the mpact of the Exchange Rate echansm (ER) of the European onetary ystem on the exports of the orgna EC members (Germany France Itay Begum and The Netherands) and found that the reducton n exchange rate voatty beteen 979 and 99 sgnfcanty benefted ntra-ec trade for a sectors (except machnery and transport equpment here the resuts ere more mxed). Fountas and Arstoteous (999) aso examned the mpact of the reducton n exchange rate varabty brought by the ER on the voume of ntra-european exports. An export demand functon as estmated for the four argest EC economes (France Germany Itay and the Unted Kngdom) for the perod 973 and 996 usng mutvarate contegraton technques and error-correcton modes ncudng an exchange rate voatty term and a dummy varabe for membershp of the ER. The resuts pont to a negatve reatonshp beteen exchange rate voatty and ntra-european exports. Hoever the dummy for ER membershp turned out to be nsgnfcant. Overa these resuts sho some potenta for promotng ntra-eu trade th the creaton of the E and the subsequent reducton n exchange rate voatty. Ths process contnued th the emnaton of exchange rate voatty beteen the euro area countres foong the adopton of the euro n 999. Thus a pror the creaton of the snge currency may have the potenta to trgger an addtona ntra euro-area trade promoton effect see Rose (). What does our dataset te us about recent trends n the evouton of extra and ntra-euro area mports of manufactures? In genera mport voumes of manufactures rose sgnfcanty over the sampe perod th extra-euro area mports generay grong more rapdy than ntra-euro area mports. Ths s shon n Chart hch shos the genera decne n the rato of ntra- Incuded sectors are: food and beverages crude materas and os chemcas manufactures and machnery and transport equpment. Note that mports of manufactures account for around three-quarters of mports of goods for both ntraand extra-euro area mports. oreover ntra- and extra-euro area mports are approxmatey equa n magntude. Workng aper eres No. 53 October 5 9

11 area mports of manufactures reatve to extra-area mports. Hoever there are some sgns that the rato stopped decnng after the aunch of the euro n 999. Chart.3 Rato of ntra- to extra-euro area mport voumes of manufactures (ndex ; seas. adj.) Q 89Q3 9Q 9Q3 9Q 9Q3 9Q 9Q3 93Q 93Q3 94Q 94Q3 95Q 95Q3 96Q 96Q3 97Q 97Q3 98Q 98Q3 99Q 99Q3 Q Q3 Intra/Extra Rato In many respects t s not surprsng that extra-euro area mport voumes of manufactures gre at a faster rate than ntra-area mports over most of the sampe perod. Ths may smpy refect the fact that the rapd pace of ord trade ntegraton deveoped more rapdy than EU ntegraton. Ths may be party due to the fact that more and more countres are appearng as ne entrants n ord export markets as compettors thereby provdng an ever ncreasng number of varetes of products hch tsef stmuates trade. oreover many of the ne compettors and market entrants are from emergng market economes charactersed by qute dverse comparatve advantages n terms of natura resources and age and sk eves. By contrast the EU represents a sma number of fary homogeneous countres hose economes are aready hghy ntegrated here more mted dfferences n comparatve advantage have aready been expoted to a sgnfcant degree. Workng aper eres No. 53 October 5

12 In genera our am s to dsentange the separate mpacts of the varous factors drvng ntra and extra-euro area mports - such as changes n reatve prces demand and exchange rate voatty n order to mprove our understandng of ntra and extra-euro area trade and to dentfy the possbe reatonshps beteen the to varabes. Therefore n the next secton e derve a theoretca mode hch expans the man factors determnng mports and n the foong sectons e estmate ntra and extra-euro area mport functons based on ths mode.. Theoretca foundatons of the mode In a smar fashon to Anderton and kudeny () e ntroduce exchange rate uncertanty nto the utty functon of a frm hch buys goods n order to rese them. Our approach buds upon the frameork deveoped by Cushman (986) ho nvestgates the mportance of exchange rate uncertanty for an exportng frm. We appy a smar frameork to an mportng frm by extendng the mode so that t captures the varous degrees of exchange rate uncertanty assocated th dfferent mport suppers. The nputs used by our mportng frm can be purchased from three dfferent suppers: home suppers hch embody zero exchange rate uncertanty; euro area suppers hch embody some degree of exchange rate uncertanty pror to 999 (.e. ntra-euro area trade); and non-euro area suppers assocated th a reatvey hgher degree of exchange rate uncertanty (extra-euro area trade) 3. The utty functon of the mporter can under the assumpton of perfect competton be rtten as: U Q θ Var Q () here U s the utty of the frm s the prce for hch the frm ses ts products and Q s the quantty of the fna product. and are the mport prces from the non-euro area and euro area countres and prces for purchases from the domestc market respectvey expressed n the mporter s currency. and are the nputs bought from extra-euro area countres euro area countres and the home country respectvey. We assume that the frm's output s charactersed by a constant eastcty of substtuton (CE) producton functon of mports from the ord (W) and from the euro area () as e as domestc producton (): 3 In order to keep the theoretca anayss smpe e assume that a mports are nvoced n foregn currency. Anderton and kudeny () aso take nto account the nvocng currency. ee aso Hartmann (998) for the dfferent nvocng practces n EU. Workng aper eres No. 53 October 5

13 Q () The ast term of equaton () represents the rsk faced by the frm and s equa to the rsk averson factor of the frm θ mutped th the varance of profts. The rsk averson factor θ s postve hen the frm s rsk averse. We assume that exchange rate voatty s the ony uncertanty factor faced by the mporter that a contracts are nvoced n the exporter s currency and that the contract date dffers from the payment date. The mport prces and are composed of the mport prces n the exporter s currency mutped th the exchange rate (unts of mporter s currency per unt of exporter s currency): * * and th ( ) the exchange rate of the mporter vs-à-vs the exporter ( or respectvey). Therefore e can rte the varance of profts as: Var Q * ( ) var( ) (3) cov for any and k. Ths assumpton mght seem somehat assumng that ( ) k restrctve as exchange rates tend to move together qute often. Hoever n ths context e assume ndependence ony beteen exchange rate movements of ntra- th extra-euro area countres hch s somehat ess restrctve. The frm maxmse profts th respect to nputs bought at home n non-euro area and n euro area countres respectvey. Usng the resutng frst order condton of the maxmsaton probem th respect to mports from country ( ) and dong some transformatons (see Appendx A for more detas) yeds: Y (4) ( ) var( ) var 5 th Workng aper eres No. 53 October 5

14 5 4 3 Y Y θ θ Equaton (4) states that extra-euro area mport voumes of the frm stuated n the euro area are postvey affected by rea ncome (defated by the suppy prce of the frm) beng postve. oreover a rse n the batera mport prce reduces mport demand ( s negatve) he a rse n the eghted average of mport prces from the other suppers (the home country and the euro area) ncreases mport demand ( 3 s postve). Fnay f the mporter s rsk averse.e. f θ s postve batera exchange rate voatty negatvey affects mport demand of frm for mports from outsde the euro area he exchange rate voatty nsde the euro area has a postve mpact on mports orgnatng from outsde of the euro area. Anaogousy e can rte for mports of frm from the euro area: ( ) ( ) Y var var β β β β β β (5) th 3 Workng aper eres No. 53 October 5

15 5 4 3 Y Y θ β θ β β β β 3. The estmated mode We use a quartery batera trade dataset spannng the sampe perod 989Q to Q4. Ths conssts of the mports of the majorty of the ndvdua euro-area countres (France Germany Begum/Luxembourg The Netherands Itay pan ortuga and Ireand) - separated nto mports orgnatng from other euro-area partners (ntra-euro-area mports) and mports orgnatng from thrd countres (extra euro-area mports). 4 Ths aos us to obtan estmates of the extra and ntra-euro area mport functons shon beo n specfcatons (6) and (7) by poong the data across the ndvdua euro area mportng countres. Accordngy the subscrpt x (n) represents tota extra-area (ntra-area) manufacturng mports of euro area country. ( ) ( ) t xt t x x xt x t x x t x xt x t x x x xt TD VOL VOL TFE V V 8 nt nt 4 3 n n n n n n n n (6) 4 Athough Austra and Fnand form part of the euro-area they are excuded from our sampe due to data mtatons. Greece s excuded as t as not yet a member of the euro area durng the sampe perod. 4 Workng aper eres No. 53 October 5

16 n V nt n n6 n V n n t n ( VOLnt ) n7 n( VOLxt ) n8ttdnt n9 n 93t n n nt n n3 t t n n4 xt ntfe n5 t (7) A pror e expect: > ; x x6 n n6 < ; x x7 n n7 < ; >. x3 n3 > ; x4 n4 > ; x5 n5 > here V xt (V nt ) are the extra (ntra) mport voumes of euro area country from a extra (ntra) euro-area mport suppers n perod t; x ( n ) s the extra euro-area (ntra euro-area) mport prce for extra (ntra) mports of country ; t s the domestc producer prce of mportng euro-area country ; TFE t s tota fna expendture n constant prces of mporter (hch proxes domestc demand); x and n represent fxed country effects; and TD xt (TD nt ) represents quartery tme dummes;.e. e have one dummy per quarter hch s equa to one n that quarter and zero otherse are producer prces mutped th a dummy hch s equa to zero before 993 and one afterards hch captures some mpacts possby assocated th the nge arket (ths be expaned n greater deta ater). We ntroduce dynamc adjustment nto the mode by ncudng a agged dependent varabe Fnay the mode aso aos for the possbe mpact of exchange rate voatty: VOL xt measures the degree of extra euro-area exchange rate voatty and s expected to have a negatve (postve) sgn for the extra (ntra) euro-area mport equaton as t captures both the absoute trade depressng mpact effect of voatty on extra-area mports ( x6 ) as e as any substtuton beteen extra and ntra euro-area mports due to dfferences n voatty ( n7 ). mary the parameter for VOL nt hch represents the degree of ntra-euro area exchange rate voatty s expected to have a negatve (postve) sgn for the ntra (extra) euro-area mport equaton th parameters n6 and ( x7 ) respectvey. A varabes are seasonay adjusted. Appendx B gves the detaed descrpton of the data and the sources. The above mode s estmated n a smutaneous equaton frameork usng three-stage east squares (3L). Ths aos us to take advantage of the effcency gans assocated th the Workng aper eres No. 53 October 5 5

17 possbe correaton of dsturbances across equatons. We treat the agged dependent varabes as endogenous and nstrument them usng the agged vaues of the exogenous varabes. The ndvdua country ntra and extra-euro area mport demand equatons are then estmated smutaneousy and each mportng country s aoed a dfferent country ntercept (fxed effects) he the sope coeffcents across the ndvdua countres are mposed to be the same. 6 Hoever e ao the coeffcents of each varabe to be dfferent for the ntra and extra euro-area mport equatons. Ths smutaneous estmaton frameork has the added advantage that t aos varous cross-equaton constrants to be mposed and tested. Gven the o poer of unt root tests and contegraton tests n sma sampes t as deemed that foong a contegraton-type approach as napproprate for our anayss gven our short sampe perod. 7 oreover the man advantage of testng for unt roots and carryng-out contegraton anayses s to avod the probem of spurous regresson. Hoever spurous regresson s not so key to be an mportant probem n pane estmaton (see hps and oon 999). odeng exchange rate voatty We defne exchange rate voatty as the quartery varance of the eeky nomna exchange rate return beteen countres and j. In order to obtan the tota extra- (ntra-) euro area exchange rate voatty e take the eghted average of ths varance th respect to the man extra (a ntra) countres: 5 We drop three dummes for the extra equaton and four for the ntra equaton to avod mutconearty for both equatons. 6 One mght argue that t s restrctve to mpose the same parameters apart from fxed effects for the mport demand functon for a euro area countres. Hoever ths s an accepted methodoogy n the trade terature as there are severa papers hch mpose the same parameters across somehat heterogeneous countres (see for exampe Kna and Lahr 993). In addton the ntenton here s to poo the data across countres such that e obtan resuts hch approxmate the parameters of the euro area. At the same tme the restrctons mped by the poong of data across countres combned th the systems estmaton methodoogy aos us to easy mpose and test cross-equaton restrctons so that economc constrants are satsfed (for exampe that the eastcty capturng the substtuton beteen extra- and ntra-euro area mports due to a change n ther reatve prce s the same n both the ntra- and extra-euro area mport equatons). 7 Under some crcumstances the poer of unt root tests can be ess than 3% hen the number of observatons s as o as (see hps and Zao 999). As our sampe perod extends ony from 989Q-Q4 e ony have a maxmum of 48 observatons. Doornk Hendry and Neson (999) note the emprca ack of poer of unt root tests hen the number of quartery observatons s equa to or ess than. 6 Workng aper eres No. 53 October 5

18 VOL j j 3 j j n q j J j 3 3 q and 3 k k VOL x q k K k 3 k 3 q k th j j j j for the ntra-euro area eghts and k k for the extra-euro area k k eghts j beng countres stuated nsde the euro area and k the man extra-euro area tradng partners (Unted tates Unted Kngdom eden tzerand Denmark and Japan). Charts and 3 sho the evouton of extra-and ntra-euro area voatty from 989 to. When estmatng the mport demand equatons ncudng the exchange rate voatty terms many prevous studes use a measure of voatty for the current perod. Hoever n our mode t s the percepton of the mporter of the kehood of beng negatvey affected by exchange rate voatty that s mportant. Hence e assume that the mporter uses nformaton from the past as e as the current perod for assessng the reatve rsks assocated th exchange rate voatty vs-à-vs dfferent suppers. Therefore e experment th varous movng-average measures of exchange rate voatty as such a varabe not ony captures current voatty aong th some hstory of past voatty but aso eventuay forgets epsodes of voatty hen they become od enough to be rreevant. Workng aper eres No. 53 October 5 7

19 Chart Extra-euro area voatty.5.45 BL FR GE IE IT NL T E Jan-89 Jan-9 Jan-9 Jan-9 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan- ource: BI and on cacuatons Chart 3 Intra-euro area voatty.5.45 BL FR GE IE IT NL T E Jan-89 Jan-9 Jan-9 Jan-9 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan- ource: BI and on cacuatons 8 Workng aper eres No. 53 October 5

20 4. Emprca resuts The frst three coumns of Tabe sho our 3L estmates for the ntra and extra trade equatons (6) and (7). Tabe Intra and Extra Import Equaton Estmates Imposng rce Homogenety Coeffcent t-tatstc LR-coef Coeffcent t-tatstc LR-coef Intra: V t n x TFE VOL n VOL x Extra: V t x n TFE VOL x VOL n Wad test Restrctons: x -( x3 x4 ); n -( n3 n4 ) Ch-squared 3.87 robabty.49 V: mport voumes : mport prces : producer prces 93: producer prces mutped th a dummy th a vaue of from 993 onards and otherse (.e the ong-run parameter for s the sum of both the and the 93 parameters); TFE: tota rea fna expendture; VOL: exchange rate voatty; subscrpt n for ntra-euro area subscrpt x for extra-euro area. LR-coeff ong-run coeffcent. Quartery tme dummes are ncuded n the estmated equatons but ther parameters are not reported due to ack of space. Three tage Least quares estmaton carred out by poong the data across the ndvdua euro area countres th V t- treated as endogenous and therefore nstrumented usng the agged vaues of the exogenous varabes as nstruments. ampe perod 989Q-Q4. Note that parameter n4 n the restrcton refers to the sum of the parameters for and 93 n the ntra equaton. The resuts sho that the ndvdua prce terms a have the expected sgns and are statstcay sgnfcant. For exampe the mported good s on prce eastcty s aays negatve he the competng mported good s eastcty s aays postve. 8 Wth respect to domestc producer prces e fnd the expected postve coeffcent (.e. a rse n producer prces for country Workng aper eres No. 53 October 5 9

21 resuts n substtuton aay from domestc producton toards both extra and ntra-area mports). Hoever for ntra-euro area mports e ony fnd ths postve reatonshp after 993. Ths may be party due to the mpementaton of the 99 nge arket rogramme. The atter created condtons for ncreased competton across the European Unon and may have ncreased the degree of substtutabty beteen goods across the dfferent countres of the EU. eanhe as expected the coeffcent for the demand varabe (TFE) s postve and sgnfcant for both the ntra and extra euro-area mport demand equatons. We aso fnd that the ong-run TFE parameter s smaer for ntra euro-area mports reatve to extra refectng the soer groth of ntra euro-area mport voumes reatve to extra-area mport voumes over our sampe perod. mary the coeffcents of the exchange rate voatty terms are a statstcay sgnfcant and have the expected sgn. For exampe extra-euro area mports decne n response to an ncrease n extra-area exchange rate voatty (.e the trade depressng and substtuton mpact of voatty) and rse n reacton to an ncrease n ntra-area voatty (.e. substtuton effect) he ntra-euro area mports decne n response to an ncrease n ntra-area voatty and rse n reacton to an ncrease n extra-area voatty. 9 These resuts mpy that exchange rate voatty assocated th a partcuar regon has a negatve mpact on trade vs-à-vs that regon and aso eads to trade beng substtuted aay from that regon toards oer-voatty regons. Another genera resut evdent from Tabe s that the parameter estmate for the agged dependent varabe s arger for ntra-area mports n comparson to extra euro-area mports. Ths fndng seems to ndcate that ntra mports have a hgher degree of persstence (stabty) than extra-area mports (.e. ntra mports aays reman coser to ther prevous agged vaues than extra-area mports). 8 Athough t s possbe that ntra and extra-area mports may be compements the emprca resuts are n ne th our assumpton that they are substtutes. 9 We expermented th dfferent movng averages of the voatty term and found that a movng average over four years seems to be most approprate both n terms of the sze of the effect and n the expanatory poer of the equaton. Ths s smar to the exchange rate voatty measures used n Anderton and kudeny (). Workng aper eres No. 53 October 5