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September/October 2001, 
Vol. 83, No. 5
Posted 2001-09-01

Reconsidering the Trade-Creating Effects of a Currency Union

by Michael R. Pakko and Howard J. Wall

This paper reconsiders recent empirical evidence found by Andrew Rose that countries adopting a common currency will triple their bilateral trade. The authors find that this large estimated effect is due to estimation bias arising from missing and/or misspecified time-invariant factors rather than to the adoption of a common currency. The results of this study, obtained with a general specification of time-invariant factors, indicate that a common currency actually leads to a small reduction in trade over a 5-year period, although this result is not statistically different from zero. The authors also find that over 10- and 20-year periods, trade volumes are more than halved by the adoption of a common currency.

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