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The endogeneity of optimum currency areas in light of pan-European intra-industry trade patterns and business cycle synchronicity

  • The creation of a common European currency has been scrutinized in the context of optimum currency area theory since its origin in Mundell (1961). The debate gained particular prominence in light of the ’endogeneity’ theorem (Frankel and Rose, 1998), which argues that, once two countries establish a common currency, their economic structures and cycles increasingly align due to strengthening intra-industry trade. By contrast, the ’specialization’ theorem (Eichengreen, 1992; Krugman, 2013) argues that the creation of a currency union will predominantly increase inter-industry trade, ultimately lowering business cycle correlation. To test these views, we establish several indices of bilateral trade intensity across EU members using input-output data, measuring gross and so-called ’value-added’ trade, which also considers the contribution of intermediary goods in the production of final exports. The results of the fixed effect panel framework indicate a strong and robust empirical relationship between growth correlations and intra-industry trade, much in line with both Mundell’s and Frankel and Rose’s theories. However, we cannot establish a similarly robust relationship between total trade intensity and growth correlations. We reconcile these results by identifying a statistically significant relationship between economic alignment and trade when only considering industrial production, highlighting the importance of pan-European industrial supply chains for European economic integration. In contrast to the EU-28, the Eurozone does not display properties of an Optimum Currency Area. We partially attribute this to the Eurozone periphery, which shows a high degree of misalignment within itself; excluding the Eurozone periphery from our initial regressions further improves the results.

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Document Type:Working Paper
Author:Frank Niklas Steinert, Wilhelm Althammer
Chairs and Professorships:Chair of Macroeconomics
Parent Title (English):Working on Europe Paper Series
Place of publication:Maastricht
Publisher:Studio Europa Maastricht
Year of Completion:2023
Page Number:39
Tag:Business Cycle Synchronicity; European Union; Input-Output Data; Intry-Industry Trade; Optimum Currency Area
Content Focus:Academic Audience
Licence (German):License LogoUrheberrechtlich geschützt