Emerging Currency Blocs

Using the gravity model to examine bilateral trade patterns throughout the world. we find clear evidence of trading blocs in Europe. the Western Hemisphere, East Asia and the Pacific. In Europe, it is the EC that operates as a bloc, not including EFTA. Two EC members trade an extra 55 per cent more with each other. beyond what can be explained by proximity, size. and GNP/capita. We also find slight evidence of trade-diversion in 1990. Even though the blocs fall along natural geographic lines. they may actually be "super-natural." Turning to the possibility of currency blocs, we find a degree of intra-regional stabilization of exchange rates, especially in Europe. Not surprisingly. the European currencies link to the OM. and Western Hemisphere countries peg to the dollar. East Asian countries, however, link to the dollar. not the yen. We also find some tentative cross-section evidence that bilateral exchange rate stability may have a (small) effect on trade. A sample calculation suggests that if real exchange rate variability within Europe were to double, as it would if it returned from the 1990 level to the 1980 level, the volume of intra-regional trade might fall by an estimated 0.7 per cent.