New Study on Trade Effects of Monetary Unification

Johnny Munkhammar reports about a new study by two Swedish economists (written in Swedish), Harry Flam and Håkan Nordström, on the effects of the European Monetary Union on trade. And they found that the introduction of the euro have boosted trade within the euro-zone by 13-14% between 1998 and 2005. A number they have come up with by first comparing how much intra-euro zone trade increased with the increase in trade with 10 OECD countries (Denmark, Sweden, Norway, Britain, Switzerland, the United States, Canada, Australia, New Zealand and Japan) in a control group. Then they compared the increase in trade between the euro zone and the control group with the increase in trade between the 10 countries in the control group. And then finally, they tried to adjust for the effects of different other factors that should influence the level of trade, such as economic growth, inflation, nominal exchange rates etc.

Their conclusion was further supported by the fact trade increased particularly much for the kind of input goods expected to increase in trade particularly much if the euro stimulated so-called vertical specialization i.e. the specialization of different stages of production over national borders.

Their methodology seem to be basically sound, but there are actually two reasons for believing they've underestimated the positive effect. First of all, they've statistically accounted for differences in economic growth. While that is basically valid as economic growth do influence trade and is mostly caused by factors unrelated to monetary unification. But if trade have really increased then that would raise economic growth. And secondly, the 13-14% number was the difference between the increase in intra euro zone trade and the increase in trade between euro zone countries and the control group. But as statistically adjusted trade between euro zone countries and the control group have increased a lot more than trade between countries in the control group, then there is reason to believe the euro have stimulated trade there too, which also means the boost to intra euro zone trade is larger.

One should always of course take results like this with a grain of salt. Statistically adjustments for the effects of other factors is likely to be inprecise and incomplete and so this result could very well be wrong with a number of percentage points. And as always, this result need not be applicable on other countries in other historical eras as there are no quantitative economic laws. However, for reasons explained above, the results are more likely to err on the downside than on the upside.

The authors end with a final qualification, namely that their study only takes on the issue of the effects of the monetary union on trade, and does not consider the effects of different monetary policies inside and outside the monetary union. A very valid qualification. In a world with a global gold standard, there is no question that a global monetary union would be the optimal monetary order. However, now that the world relies on fiat money, the issue gets more complicated. A monetary union is superior in any case compared to fixed exchange rates as it removes transaction costs. A monetary union is also superior to floating exchange rates provided that the monetary policy in the monetary union is better, equally bad or marginally worse than what would have been the case with an independent monetary policy. It would however be beneficial for a country to opt out of a monetary union if the independent monetary policy would be considerably better ( i.e. less inflationary) than that of the monetary union. In the case of Sweden, monetary policy outside the euro zone have not proven to be less inflationary.