Currency unions: which effects for trade?

Our paper provides a theoretical analysis of the potential trade implications of a currency union focusing on the crucial role of economic dissimilarities among countries. Modeling the adoption of a common currency as the elimination of transaction costs on international trade, we show that a currency union enhances bilateral trade among members while it reduces bilateral trade between members and excluded countries. Furthermore, focusing on the eventual enlargement of the currency union, we evaluate the implications of the initial level of trade integration as well as of the existence of dissimilarities between member countries and accession countries on the potential gains in trade. We formally show that the higher is the initial level of trade integration between members and new entrants, the greater would result the potential gains in trade following the enlargement of the currency union. Moreover we prove that, under some conditions, the more dissimilar new entrants are with respect to the original members, the smaller would be the potential gains in terms of bilateral trade.