Economic Effects of Currency Unions

FRB of Boston Working Paper No. 02-4

28 Pages Posted: 3 Mar 2003

See all articles by Silvana Tenreyro

Silvana Tenreyro

London School of Economics (LSE)

Robert J. Barro

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: December 2002

Abstract

This paper develops a new instrumental-variable (IV) approach to estimate the effects of different exchange rate regimes on bilateral outcomes. The basic idea is that the characteristics of the exchange rate regime between two countries (exchange rate variability, fixed or float, autonomous or common currencies) are partially related to the independent decisions of these countries to peg - explicitly or de facto - to a third currency, notably that of a main anchor. Our approach is to use this component of the exchange rate regime as an IV in regressions of bilateral outcomes. We illustrate the methodology with one specific application: The economic effects of currency unions. The likelihood that two countries independently adopt the currency of the same anchor country is used as an instrument for whether they share or not a common currency. Three findings stand out. First, sharing a common currency enhances trade, supporting previous work by Rose [2000]. Second, a common currency increases price co-movements; this finding is consistent with the observation that a large part of the variation in real exchange rates is caused by fluctuations in nominal exchange rates. Finally, a common currency decreases the co-movement of shocks to real GDP. This is consistent with the view that currency unions lead to greater specialization.

Keywords: Currency Union, Exchange Rate Regime, Instrumental Variable, Trade, Comovement

JEL Classification: F1, F3, F4, E32

Suggested Citation

Tenreyro, Silvana and Barro, Robert J., Economic Effects of Currency Unions (December 2002). FRB of Boston Working Paper No. 02-4, Available at SSRN: https://ssrn.com/abstract=366220 or http://dx.doi.org/10.2139/ssrn.366220

Silvana Tenreyro

London School of Economics (LSE) ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Robert J. Barro (Contact Author)

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-495-3203 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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