Emerging Currency Blocs

Abstract

Using the gravity model to examine bilateral trade patterns throughout the world, we find clear evidence of trading blocs in Europe, the Western Hemisphere, East Asia, and the Pacific. In Europe, it is the EC that operates as a bloc, not including EFTA. Two EC members trade an extra 55 percent more with each other, beyond what can be explained by proximity, size, and GNP/capita. Turning to the possibility of currency blocs, we find a degree of intra-regional stabilization of exchange rates, especially in Europe. Not surprisingly, the European currencies link to the DM, while Pacific currencies link to the dollar. We also find some cross-section evidence that bilateral exchange rate stability may have had a (small) role in promoting intra-bloc trade during the period 1965-1980. In 1980, lower exchange rate variability within Europe, compared to the worldwide norm, increased trade by 4.4 percent, by one estimate (less, in an estimate that corrects for simultaneity). Even the small negative effects we estimate appear to have disappeared during the course of the 1980s, perhaps due to the proliferation of instruments to hedge exchange risk.

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