Reconsidering the trade-creating effects of a currency union

This paper reconsiders recent empirical evidence found by Andrew Rose that countries adopting a common currency will triple their bilateral trade. The authors find that this large estimated effect is due to estimation bias arising from missing and/or misspecified time-variant factors rather than to the adoption of a common currency. The results of this study, obtained with a general specification of time-variant factors, indicate that a common currency actually leads to a small reduction in trade over a 5-year period, although this result is not statistically different from zero. The authors also find that over 10- and 20-year periods, trade volumes are more than halved by the adoption of a common currency.