On The Causes and Consequences of Currency Unions

Why do countries participate in currency unions or unilaterally adopt a foreign currency? I investigate the roles of geography, synchronization of economic shocks, cultural similarity, size, political integration and colonial heritage as determinants of monetary unions. The results motivate a selection model for common currency areas, which I then use to revisit the impact of currency-union membership on trade. I argue that previous studies that do not account for endogenous selection tend to produce estimates with a large positive bias. Correcting for selection, I find that the evidence for an enhancement effect of currency unions on trade is weaker than previously documented. ∗Department of Economics, Littauer Center 2000, Harvard University, Cambridge, MA 02138; e-mail: . For helpful comments, I would like to thank Alberto Alesina, Robert Barro, Francesco Caselli, Doireann Fitzgerald, Robin Greenwood, Juan Carlos Hallak, Elhanan Helpman, Kenneth Rogoff, Shang-Jin Wei, Jeffrey Wurgler and seminar participants at Harvard.