The Direct Effect on Norwegian Exports of a Disbandment of the Euro Area : An Econometric Analysis

Abstract

The purpose of this thesis is to examine the direct effect on Norwegian exports of a hypothetical disbandment of the euro area. This is done by looking at what happened to Norwegian exports when the euro was introduced in two steps in 1999 and 2002. An export determination model is derived from theory, in which the amount of exports depends on foreign demand, relative prices and real capital in production. Step-dummy variables for the introduction of the euro are included in the model in order to account for the direct effect on Norwegian exports of the introduction of the euro.

The hypothesis is that the introduction of the euro led to substitution away from Norwegian products as a result of the lower transaction costs and the lower risk of exchange rate volatility within the currency union. In other words, the introduction of the euro gave Norwegian exporters a disadvantage as compared to their competitors in the euro area. If the euro area were to be disbanded, this disadvantage would disappear. Hence, in failing to reject the hypothesis, the conclusion will be that a disbandment of the euro area would lead to a positive direct effect on Norwegian exports.

Two versions of the model are examined, one in which the amount of exports in each period is determined only by demand side variables or only by supply side variables; and one whereby the amount of exports in each period is determined by both demand side variables and supply side variables at the same time. Three different production sectors of Norwegian industry are investigated - various industry products, metals and machinery products. An econometric analysis is performed in order to find a cointegrating relationship between the amount of exports and the explanatory variables.

The empirical analysis of the first version of the model produces coefficients with signs inconsistent with theory, and this version is therefore not a good fit to the data. The second version returns significant coefficients with signs consistent with theory, and proves to be a better fit. The empirical analysis of the second version fails to reject the hypothesis of a negative direct effect on Norwegian exports of the introduction of the euro for various industry products and machinery products. For metals, the direct effect is negative in 1999 and positive in 2002, and the aggregated effect is likely to not be significantly different from zero. The conclusion is thus, that a disbandment of the euro area would lead to an increase in the amount of exports of various industry products and machinery products, whereas the direct effect on the amount of exports of metals is not likely to be significant. It is however important to note that the expected positive direct effect on Norwegian exports of various industry products and machinery products is likely to be outweighed by negative effects that are not discussed in this thesis.