Microfoundations of the euro’s effect on euro area trade hinge on the timing, the
speed and the size of adjustment in trade costs. We estimate timing, speed and size
of adjustment in trade costs for sectoral trade data. Our approach allows for sector
specific impacts of trade costs on sectoral trade while controlling for unobserved but
time-variant variables at the sector level. We find that, due to falling trade costs,
trade within the euro area increases between the years 2000 and 2003 by 10 to 20
percent compared with trade between European countries that are not members of
the euro area. Adjustment of individual sectors is extremely fast whereas aggregate
adjustment spreads out because different sectors adjust at distinct times.
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