The Role of Cross-Sectional Heterogeneity for Magnitude and Timing of the Euro's Trade Effect

This paper examines the role of cross-sectional heterogeneity for estimating the euro's effect on euro-area trade. In the empirical analysis, the impact of trade costs on trade and the transition dynamics to the new monetary regime can vary cross-sectionally in trade sectors and country pairs. Unobserved state variables that account for time-varying and omitted trade costs and multilateral resistance terms can also vary cross-sectionally. The results show that cross-sectional heterogeneity is strongly supported by the data and that the average euro effect coincides with consensus estimates. Decomposing the average effect uncovers large cross-sectional heterogeneity in its magnitude. Also, the average trade effect unfolds only gradually over time, since it is composed of many trade sectors that adjust at different dates.