Working Paper: NBER ID: w5700
Authors: Jeffrey A. Frankel; Andrew K. Rose
Abstract: A country's suitability for entry into a currency union depends on a number of economic conditions. These include, inter alia, the intensity of trade with other potential members of the currency union, and the extent to which domestic business cycles are correlated with those of the other countries. But international trade patterns and international business cycle correlations are endogenous. This paper develops and investigates the relationship between the two phenomena. Using thirty years of data for twenty industrialized countries, we uncover a strong and striking empirical finding: countries with closer trade links tend to have more tightly correlated business cycles. It follows that countries are more likely to satisfy the criteria for entry into a currency union after taking steps toward economic integration than before.
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Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increased trade integration (F15) | Increased correlation of business cycles (F44) |
| Initial economic integration (F15) | Enhanced trade links (F19) |
| Enhanced trade links (F19) | Increased correlation of business cycles (F44) |
| Increased correlation of business cycles (F44) | Increased suitability for currency union membership (F36) |