In this paper, we estimate a gravity equation properly accounting for omitted exporter and importer's overall trade resistance, through country-yearly dummies for exporter and importer countries. We find that the omission of time-varying multilateral trade resistance terms in the estimation of a gravity equation introduces important biases in the results, although correcting them means we can only compute differences between actual and predicted export shares, instead of levels, as usually done. An application to the calculation of trade potentials in the Euromed region (Southern and Eastern Mediterranean countries)shows that the omission of time-varying multilateral trade resistance terms greatly influences the computation of export potentials as well as the estimated effect of signing a free trade agreement. Overall, we find that, except for Algeria, Jordan and Lebanon, Euromed countries' share of exports to the EU as a whole is at, or slightly above, those predicted by a correctly-specified gravity model, although the share of exports to some individual EU countries is significantly below the predictions of the gravity model. Except for those three countries, we find significant opportunities for export growth to the US, instead.

Simposio de Análisis Económico for helpful comments. The views expressed in this papers are those solely of the authors and do not reflect the views of Banco de España or the Eurosystem.

International Macroeconomics has long sought an explanation for current account fluctuations that matches the data. The approaches have typically focused on better models and new macroeconomic variables. We demonstrate the limitations of this approach by showing that idiosyncratic shocks are an important cause of macroeconomic volatility even for large countries. When explaining these fluctuations, standard macroeconomic models generally assume that firms are small and that their microeconomic shocks cancel out. We show that the high degree of concentration of bilateral trade flows means that idiosyncratic shocks can have a significant impact on aggregate economic fluctuations. We theoretically develop a descomposition components. Taking the model to data on bilateral trade flows from 1970 to 1997, we find that the most comprehensive macroeconomic model can only account for at most half of the observed variance in trade account volumes of each country. Thus, this paper highlights the importance of considering disaggregated data when modeling the current account.

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