BILATERAL TRADE AND CURRENCY UNION: EVIDENCE FROM THE EUROZONE.

Due to the financial crisis that has already revealed many of the shortcomings of the Eurozone, it has become clear that keeping the Eurozone together has its costs and that they may be larger than previously expected. The question arising now is whether these costs can still be justified by the benefits that come with the currency union. While many of the benefits such as greater unity, stability and influence in a geopolitical sense are hard to quantify, previous research suggests that adopting a common currency also has more tangible advantages such as lower inflation and increased bilateral trade among member countries. This paper focuses on quantifying those benefits and finding a causal effect between joining a currency union and an increase in bilateral trade. In this paper we undertake a difference-in-differences analysis to answer a simple question: what happened to the trade of the new member countries after their entry into the Eurozone relative to the counterfactual approximated by the rest of the EU members who did not join during the relevant time period? The importance and difficulty of finding a convincing group of control countries led us to examine what happened to bilateral trade of some of the most recent Eurozone joiners, more specifically those joining after 2004. We used a conventional gravity approach for the main regression and the results fall within the range of previous estimates for the effect of joining the Eurozone on bilateral trade. More precisely, we have found that trade between the new member countries and their Eurozone partners has gone up by around 8% to 10% whereas the trade with non-Eurozone countries has not changed. [ABSTRACT FROM AUTHOR]