Out in the Cold? Iceland's Trade Performance Outside the European Union and European Monetary Union

Abstract

Although entering a currency union involves both costs and benefits, an increasing body of research is finding that the benefits – in terms of international trade creation – are remarkably large. For example, Rose (2000) suggests that countries can up to triple their trade by joining a currency union. If true the impact on trade, income and welfare should Iceland join EMU could be enormous. However, by focusing simply on EMU rather than the broad range of currency unions studied by Rose, we find that the trade impact of EMU is smaller – but still statistically significant and economically important. Our findings suggest that the Iceland's trade with other EMU countries could increase by about 60% and that the trade-to-GDP ratio could rise by 12 percentage points should Iceland join the EU and EMU. This trade boost could consequently raise GDP per capita by roughly 4%. These effects would be even larger if the three current EMU outs (Denmark, Sweden and the UK) were also to enter EMU.

Keywords: currency unions, international trade, Iceland

JEL Classification: F15, F33