Estimating the Effect of Common Currencies on Trade: Blooming or Withering Roses?

Using a gravity model and data on 182 countries worldwide, this paper estimates the effects of exchange rate volatility and currency unions on international trade for ten years spanning 1980 through 2010. We provide added confirmation and further strengthen the empirical findings in Rose (2000) prior to 1999, but we find a gradually diminishing Rose effect for the 2000-2010 period, when the Euro Zone is added to the currency union dummy. The rest of the coefficients generally comply in magnitude and sign with what is standard in the “gravity” literature. Our findings support a much stronger effect of a currency union on trade than the hypothetical effect of reducing exchange rate volatility to zero.