NBER WORKING PAPER SERIES

ONE MONEY, ONE MARKET:ESTIMATING THE EFFECT OF COMMON

CURRENCIES ON TRADE

Andrew K. Rose

Working Paper 7432http://www.nber.org/papers/w7432

NATIONAL BUREAU OF ECONOMIC RESEARCH1050 Massachusetts Avenue

Cambridge, MA 02138December 1999

This paper began in a series of conversations with Harry Flam; without him, the paper would not have beenwritten. I also thank Nils Bohlinda, Rob Feenstra, Michael Ferrantino and Gian-Maria Milesi-Ferretti for helpwith the data, and Joshua Aizenman, Samuel Bentolila, David Begg, Michele Boldrin, Dick Cooper, BarryEichengreen, Charles Engel, Antonio Fatas, Raquel Fernandez, Michael Ferrantino, Jeff Frankel, Jeff Frieden,Miriam Green, Elhanan Helpman, Harry Huizinga, Ben Lockwood, Rich Lyons, Danny Quah, Richard Portes,Assaf Razin, Helene Rey, Ken Rogoff, Andre Sapir, Larry Schembri, Alan Winters, Charles Wyplosz,seminar participants at DG2 and Harvard, and the members of the Economic Policy panel for comments andencouragement. Asher Isaac provided inspiration. The data set and a current version of the paper areavailable at my website. The views expressed herein are those of the authors and not necessarily those ofthe National Bureau of Economic Research.

© 1999 by Andrew K. Rose. All rights reserved. Short sections of text, not to exceed two paragraphs, maybe quoted without explicit permission provided that full credit, including © notice, is given to the source.

One Money, One Market: Estimating the Effect of Common Currencies on TradeAndrew K. RoseNBER Working Paper No. 7432December 1999JEL No. F33

ABSTRACT

A gravity model is used to assess the separate effects of exchange rate volatility and currency

unions on international trade. The panel data set used includes bilateral observations for five years spanning

1970 through 1990 for 186 countries. 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 endogenous nature of the exchange rate regime. These

effects are statistically significant and imply that two countries that share the same currency trade three times

as much as they would with different currencies. Currency unions like EMU may thus lead to a large

increase in international trade, with all that entails.

Andrew K. RoseHaas School of BusinessUniversity of CaliforniaBerkeley, CA 94720-1900

B.T. Rocca Jr. Professor of International BusinessEconomic Analysis and Policy Groupand NBER, CEPRarose@haas.berkeley.eduhaas.berkeley.edu/~arose