The effect of the euro on trade, income and prices

The first paper uses European data to estimate the euro effect on bilateral trade. An extended gravity model and a variety of fixed effects estimators are used to robustly quantify the results. The estimates are then compared to similar ones obtained with both European and non-European data. The findings are consistent with previous studies - the euro has increased bilateral trade by between 9% and 38% for the first 10 years. The link between the euro and trade is crucial for analysing the benefits of common currencies in terms of business cycle synchronization and standards of living. The results strengthen the argument in favour of common currencies in general, and euro adoption in particular. The second paper uses European data to estimate the effect of trade on income. A growth equation and an instrumental variable approach are used in a Two-Stage-Least-Squares regression. The estimates are then compared to similar ones obtained with non-European data. The findings are consistent with previous studies – a 1% increase in the trade to GDP ratio increases income by between .25% and 1.21% . This result provides a link between the euro, trade and income. In particular, it suggests that more trade, resulting from common currencies, increases standards of living. The finding is of utmost policy relevance for countries considering joining a common currency in general and the euro in particular. The third paper investigates to what extent prices become more flexible after a country adopts the euro. If price flexibility is significantly enhanced, it can potentially offset some of the negative effects of a common currency, such as the lack of monetary independence and exchange rate adjustment in the face of asymmetric shocks. Thus, one of the main drawbacks of a monetary union would be discredited. The evidence suggests a small positive effect of the euro on price flexibility based on time-series micro data from six euro countries.