Reuven Glick and Andrew K. Rose of the San Francisco Federal Reserve write: The economic benefits of sharing a currency like the euro continue to be debated. In theory, countries that use the same currency face lower trade costs and exchange rate risk and are able to compare prices across borders more easily. These advantages should help increase trade among the economies involved. New estimates suggest that this has been the case in Europe, though perhaps to a lesser degree than previously thought.
The costs of forgone national control of monetary policy have become particularly apparent for member countries like Greece.
We earlier estimated how the amount of trade between two countries related to whether they were in a currency union. We looked at more than 200 countries from 1948 to 1997, before the establishment of the EMU. We found that bilateral trade approximately doubled as a pair of countries formed and halved when a currency union dissolved.
Many other things affect trade, so the interaction of all these factors makes it difficult to isolate and measure the effect of currency unions. Our data set consists of almost 900,000 bilateral trade observations for roughly 200 countries from 1948 to 2013.
During our sample period, a large number of countries joined or left currency unions. By far the biggest recent event in monetary unions was the establishment of the EMU, which began with 11 member countries in 1999 and has since expanded to 19 members.
To see what the data can show about the effect of currency unions on international trade we measure trade as the average of exports and imports between each pair of countries and use a “fixed effects” estimator.
This approach suggests currency unions have a positive effect on trade. The EMU is estimated to raise trade by around 50%, while non-EMU currency unions boost exports by over 100%.
The magnitude of exports between any two countries depends not only on their level of bilateral trade resistance but also on how difficult it is for each of them to trade with the rest of the world – what they call multilateral resistance. With all other things held constant, higher levels of multilateral resistance should be associated with higher bilateral trade.
With this second approach, the EMU raises exports by roughly 50%, similar to our first estimation approach.
We are also interested in estimating the effects of currency unions over time, including how much trade is affected before and after the year of entry or exit from a currency union. As shown in Figure 1, the EMU has a positive effect on trade even before entry, and it increases further in the years after entry. This is consistent with the view that the path followed by policymakers as they prepared to launch the euro was credible enough to lock in expectations about exchange rates before the euro’s formal adoption in 1999.
Effects of EMU entries on exports
The costs and benefits of sharing a common currency through membership in the EMU or any other currency union continue to be debated. The costs of forgoing national monetary policy control and giving up the ability to change the exchange rate are particularly apparent for member countries such as Greece. These costs must be weighed against the benefits of belonging to a currency union, including the greater trade and investment fostered by the lower transaction costs of changing currency, lower exchange risk, and the greater transparency of price comparisons across countries.
We estimate the effect of the EMU and other currency unions on trade using annual data that cover more than 200 countries between 1948 and 2013, including 15 years since the EMU was established. Our results suggest the EMU has a stimulating effect on trade. It is these benefits, among others, that presumably give Greece a strong reason to remain in the EMU.