One Money, One Market: Estimating the Effect of Common Currencies on Trade

A gravity model is used to assess the separate effects of exchange rate volatility and currency unions on international trade. The panel data set I use includes bilateral observations for five years spanning 1970 through 1990 for 1986 countires. 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 endogenuous nature of the exchange rate regime. These effects are statistically significant and imply that two countires that share the same currency trade three times as much as they would with different curencies. EMU may thus lead to a large increase in international trade, with all that entails.