This paper considers the nature and the distribution of trade and FDI effects of a potential enlargement of the European Monetary Union (EMU) to the 10 countries that obtained EU membership in 2004. One-way and two-way error component gravity models are estimated using a data set of unbalanced panel data that combine bilateral trade flows among 29 countries and the distribution of outward FDI stocks among these countries. The results reveal a complementarity between trade and investment and a relationship between trade and exchange rate volatility that depend on the sign of bilateral trade balances. Using a simulation-based technique, we find that estimates of FDI effects of EMU range between 18.5% for Poland and 30% for Hungary.

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Keywords EMU, FDI, exchange rate volatility, foreig direct investment, trade diversion, vertical integration
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Brouwer, J, Paap, R, & Viaene, J.M.A. (2008). The trade and FDI effects of EMU enlargement. Journal of International Money and Finance: theoretical and empirical research in international economics and finance, 27(2), 188–208. doi:10.1016/j.jimonfin.2007.12.005