The Estimated Trade Effects of the Euro

Abstract

Applying the gravity model to a data set that was sufficiently large to encompass a number of currency unions led to an eye-opening finding: members of currency unions traded with each other an estimated three times as much as with otherwise similar trading partners. The trade effects of monetary union are not entirely limited to small countries. The statistical association between currency links and trade links might not be the result of causation running from currencies to trade but might arise instead because both sorts of links are caused by a third factor, such as colonial history, remaining political links, complementarity of endowments, or accidents of history. The third critique also concerns causality: the endogeneity of the currency decision. Countries choose as partners for currency links the neighbors with whom they trade the most rather than the other way around. The problem of endogeneity is probably the most serious stumbling block as a causal relationship between the currency decision and trade patterns.

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