Working Paper: CEPR ID: DP2329
Authors: Andrew K. Rose
Abstract: A gravity model is used to assess the separate effects of exchange rate volatility and currency unions on international trade. The panel data set used includes bilateral observations for five years spanning 1970 through 1990 for 186 countries. In this data set, there are over one hundred pairings and three hundred observations, in which both countries use the same currency. I find a large positive effect of a currency union on international trade, and a small negative effect of exchange rate volatility, even after controlling for a host of features, including the endogenous nature of the exchange rate regime. These effects are statistically significant and imply that two countries that share the same currency trade three times as much as they would with different currencies. Currency unions like EMU may thus lead to a large increase in international trade, with all that entails.
Keywords: empirical; panel; union; country; exchange rate volatility; gravity model
JEL Codes: F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| common currency (F36) | increased international trade (F10) |
| exchange rate volatility (F31) | decreased international trade (F19) |
| common currency (F36) | decreased effect of exchange rate volatility on trade (F31) |
| exchange rate volatility (F31) | international trade (F19) |
| inflation rates (E31) | exchange rate volatility (F31) |