Has Euro Increased Trade Within Euro-Zone?

EC307: Macroeconomic Policy in the EU

Topic: Has Euro increased trade within Euro-zone?

Introduction

Before the introduction of Euro, currency areas were restricted by territory borders. The pathbreaking contribution by Mundell (1961) triggered violent arguments on the benefits and costs of joining the European Monetary Union (EMU). It was widely believed by governments and the public that the costs are mainly macro, associated with the loss of monetary policy independence. On the other hand, the common currency would accelerate the economic growth and integration, so that the benefits would be weighed against the costs.

One important aspect of the EU market growth is the increase in Euro-zone trade.

In this essay, base on the statistical facts of the EMU and the results of previous papers in this area, we will investigate the questions: Has Euro increased trade within the Euro-zone? What are the possible reasons behind this?

Has Euro increased trade?

Results given by different approaches varied greatly. The first paper who directly looked into this problem was Rose (2000). He constructed a gravity model to estimate the effect of Euro, and found that the monetary union would triple the trade among its members. Although this result received lots of scepticism, with his gravity equation framework with the currency union dummy, he was indeed a remarkable pioneer and simulated lots of further researches in this area.

The model not only linked the value of trade with countries’ currency, exchange rate, real GDP, population and distance, but also took factors like common language, colony history into consideration. The model states that the value of trade between two countries, increases with their sizes (GDP), decreases with distance, and would triple if they join one currency union (CU).

Though Rose checked the robustness extensively with sensitivity analysis, we can still find some problems likely to lead to biased outcome. Firstly, the data...