Effects Of Currency Unions Research Articles

How Big and Heterogeneous are the Effects of Currency Arrangements on Market Integration? A Price Based Approach

A rapidly expanding literature studies the effect of currency union and other exchange rate arrangements on goods market integration. All existing studies employ a methodology based on observed volumes of trade. However, from a theoretical point of view the connection between market integration and the volume of trade is loose. In this paper, we propose a different metric of market integration, based on the dispersion of prices of identical products in different countries. This metric is motivated by the theory of arbitrage in the presence of transaction costs. We apply the methodology to a unique 3-dimensional data set that includes prices of 95 very disaggregated goods (e.g., light bulbs and toothpaste with fluoride) in 83 cities around the world from 1990 to 2000. We find that a currency board or a currency union generally provides a stimulus to goods market integration that goes far beyond merely reducing exchange rate volatility to zero. However, there are important exceptions. Long-term currency unions exhibit greater integration than more recent currency boards. All existing arrangements can improve their integration further relative to a U.S. benchmark.

The currency union effect on trade: early evidence from EMU

In this paper we estimate the early effect of the European Monetary Union (EMU) on trade. We use a panel data set that includes the most recent information on bilateral trade for 22 developed countries from 1992 through 2002. During this period 12 European countries formally entered into a currency union. This is a unique event that allows us to study the effect of currency union among a relatively homogeneous group of industrial countries. Controlling for a host of other factors, we find that the effect of EMU on bilateral trade between member countries ranges between 5 and 10 percent, when compared to trade between all other pairs of countries, and between 9 and 20 percent, when compared to trade among non-EMU countries. In addition, we find no evidence of trade diversion. If anything, our results suggest that monetary union increases trade not just with EMU countries, but also with the rest of the world.

Experience of and Lessons from Exchange Rate Regimes in Emerging Economies

The paper reviews recent trends in thinking on exchange rate regimes. It begins by classifying countries into regimes, noting the distinction between de facto and de jure regimes, but also noting the low correlation among proposed ways of classifying the former. The advantages of fixed exchange rates versus floating are reviewed, including the recent evidence on the trade-promoting effects of currency unions. The next topic is the framework for tallying up the pros and cons: the traditional Optimum Currency Area criteria, as well as some new criteria from the experiences of the 1990s. A section on the rapid rise and fall of the Corners Hypothesis notes its lack of theoretical foundations. A section on empirical evidence regarding the economic performance of different regimes notes sensitivity to the classification scheme. A listing of possible nominal anchors alongside exchange rates observes that each candidate has its own vulnerability, leading to the author's proposal to Peg the Export Price (PEP). The concluding section offers some implications for East Asia.

Currency Unions and Trade: Variations on Themes by Rose and Persson

Using a gravity equation, Andrew Rose finds that currency-union countries trade more intensively with each other than do other country pairs, and others report same result. Using a nonparametric test, however, Persson finds that trade flows between currency-union countries are not significantly different in size from other bilateral trade flows. Using another way to identify a currency-union country, this paper reproduces Persson's result but also produces an anomaly. When Rose's gravity equation is re-estimated using the data set furnished by the alternative definition of a currency-union country, Rose's result survives, although the currency-union effect is smaller than the effect he reported initially.

The Impact of Euro on EMU Trade: The (Early) Effect is not so Large

We investigate the impact of the euro adoption on commercial transactions of EMU countries. We refer to the abundant gravity-model literature about the effect of Currency Unions on trade originated by Rose (2000). We adapt this kind of modelling to the specific case of the European Monetary Union drawing from former literature some guidelines summed up as follows: distinction of pure common currency from exchange rate volatility effect; selection of sample countries strictly focused on EMU economies; consideration of time as well as space dimension; inclusion of other political factors promoting integration. We add to these provisions the observation that the panel estimation of the gravity equation must be dynamic, because EMU is a young phenomenon; short run effects, like trade persistence, can hence play a crucial role. Our main finding is that the euro adoption has had a positive but not exorbitant impact on bilateral trade of European countries (the estimated percentage increase ranges between 2.6 and 6.3%), much lower than that derivable from Rose's estimates referred to a larger and heterogeneous set of countries (providing a trade increase following the adoption of a common currency by as much as 200%). Our results refer to short-run impacts; long-run effects could be stronger (but, in our opinion, not by the order of a double or a trebling effect indicated in the existing literature on currency unions), particularly if the structural change implied by the new currency regime (a fraction of foreign trade is potentially equivalent to domestic trade) becomes completely interiorised in the perception and the behaviour of Euroland citizens.

The Currency Union Effect on Trade: Early Evidence from Emu

In this paper we estimate the early effect of the European Monetary Union (EMU) on trade. We use a panel data set that includes the most recent information on bilateral trade for 22 developed countries from 1992 through 2002. During this period 12 European countries formally entered into a currency union. This is a unique event that allows us to study the effect of currency union among a relatively homogeneous group of industrial countries. Controlling for a host of other factors, we find that the effect of EMU on bilateral trade between member countries ranges between 5 and 10 percent, when compared to trade between all other pairs of countries, and between 9 and 20 percent, when compared to trade among non-EMU countries. In addition, we find no evidence of trade diversion. If anything, our results suggest that monetary union increases trade not just with EMU countries, but also with the rest of the world.

Economic Effects of Currency Unions

This paper develops a new instrumental-variable (IV) approach to estimate the effects of different exchange rate regimes on bilateral outcomes. The basic idea is that the characteristics of the exchange rate regime between two countries (exchange rate variability, fixed or float, autonomous or common currencies) are partially related to the independent decisions of these countries to peg - explicitly or de facto - to a third currency, notably that of a main anchor. Our approach is to use this component of the exchange rate regime as an IV in regressions of bilateral outcomes. We illustrate the methodology with one specific application: The economic effects of currency unions. The likelihood that two countries independently adopt the currency of the same anchor country is used as an instrument for whether they share or not a common currency. Three findings stand out. First, sharing a common currency enhances trade, supporting previous work by Rose [2000]. Second, a common currency increases price co-movements; this finding is consistent with the observation that a large part of the variation in real exchange rates is caused by fluctuations in nominal exchange rates. Finally, a common currency decreases the co-movement of shocks to real GDP. This is consistent with the view that currency unions lead to greater specialization.

Exchange Rate Volatility and Currency Union: Some Theory and New Zealand Evidence

This paper considers the effect of currency union on exchange rate volatility. At a theoretical level, a simple framework is developed for thinking about volatility and exchange rate arrangements and some inferences are drawn from it. Empirically, the interaction between currency areas and exchange rate volatility is analysed by constructing counterfactual exchange rate series for the scenarios of currency union with Australia or with the United States from 1985 to 2001. We cannot confidently conclude that New Zealand's quarter-to-quarter exchange rate volatility would have been lower in a currency union with the United States or Australia. By contrast, cyclical variability in the New Zealand exchange rate has been greater over the last sixteen years than it would have been in a currency union with either Australia or the United States.

An Estimate of the Effect of Common Currencies on Trade and Income

To quantify the implications of common currencies for trade and income, we use data for over 200 countries and dependencies. In our two-stage approach, estimates at the first stage suggest that belonging to a currency union/board triples trade with other currency union members. Moreover, there is no evidence of trade-diversion. Our estimates at the second stage suggest that every one percent increase in a country’s overall trade (relative to GDP) raises income per capita by at least one third of a percent. We combine the two estimates to quantify the effect of common currencies on output. Our results support the hypothesis that important beneficial effects of currency unions come through the promotion of trade.

Honey, I Shrunk the Currency Union Effect on Trade

NE of the puzzles in empirical international trade is the difficulty offinding a large and statistically significant negative effect of exchange ratevariability on trade. Business managers (and also policymakers) often claim thatcurrency fluctuations are a major obstacle for international economic integration.Since volatile exchange rates generally imply uncertainty about external returns,large and frequent changes in the exchange rate are widely expected to lower thebilateral amount of trade, holding other things constant. Surprisingly, then, asubstantial body of empirical work has hardly found any association betweenexchange rate volatility and trade. In fact, this empirical result has become bynow so established that most of the latest studies do not aim to weaken thefinding, but rather try to provide explanations for it, such as the availability ofhedging instruments (see, for example, Wei, 1999).Recently, however, Andrew Rose (2000) has turned the puzzle on its head.Analysing the effect of currency unions on trade, he finds that a completeelimination of exchange rate variability not only increases trade, but that theeffect is strikingly large. In particular, Rose finds that two countries that share acommon currency trade three times more with one another than with countriesthat use a different currency.This result, apart from being notable for itself, is particularly interesting forat least two reasons. First, there has been recently a growing tendencytowards the establishment of currency unions. In Europe, twelve countrieshave decided to give up their national currencies for the euro. Moreover, agrowing number of countries seek to cure domestic economic problems byfull dollarisation, i.e. adopting a foreign currency as legal tender. Examplesinclude Ecuador in the case of the US dollar and the former Yugoslavianrepublic of Montenegro in the case of the Deutschmark. Rose’s results, then,

Honey, the Currency Union Effect on Trade Hasn’t Blown Up

as the value of real bilateral trade between‘countries’ i and j at time t, CU is a dummy variable which is unity if i and j sharethe same currency at time t, Z is a vector of controls given by an augmentedgravity model, c are the associate nuisance coefficients, and is a (hopefully)well-behaved residual. My chief finding was that was large and robust; mypoint estimate was ‹1:2, implying that currency union is associated with atripling (since exp(1.2)ˇ3) of trade.In his paper in this issue, Volker Nitsch provides three pieces of value-added.First he finds and corrects a number of data errors in my original data set. Second,he shows that adding extra controls to my empirical setup, disaggregating bycurrency unions, and adjusting for missing data affects the results. He concludesthat the effect of currency union on trade is smaller than my original estimates,has not been reliably estimated, and may be zero.

One money, one market: the effect of common currencies on trade

Currency unions Their dramatic effect on international trade A gravity model is used to assess the separate effects of exchange rate volatility and currency unions on international trade. The panel data, bilateral observations for five years during 1970–90 covering 186 countries, includes 300+ 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, statistically significant, imply that two countries sharing the same currency trade three times as much as they would with different currencies. Currency unions like the European EMU may thus lead to a large increase in international trade, with all that that entails. — Andrew Rose