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Deviations from purchasing power parity: causes and welfare costs

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  • Engel, Charles
  • Rogers, John H.

Abstract

We explore deviations from short-run purchasing power parity across European cities, attempting to move beyond a "first-generation" of papers that document very large border effects. We document two very distinct types of border effects embedded in relative prices. The first is a "real barriers effect," caused by various barriers to market integration. The second is a sticky-consumer-price cum volatile exchange-rate effect. Both are shown to be important empirically, the second type especially so. We argue that the two effects are very different from each other. For the first type of effect, it is clear that border effects imply deadweight welfare losses. We argue that while the second type of border effect could be eliminated with fixed exchange rates, welfare is not necessarily increased.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of International Economics.

Volume (Year): 55 (2001)
Issue (Month): 1 (October)
Pages: 29-57

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Handle: RePEc:eee:inecon:v:55:y:2001:i:1:p:29-57

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Web page: http://www.elsevier.com/locate/inca/505552

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References

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  1. Charles Engel, 1999. "Accounting for U.S. Real Exchange Rate Changes," Journal of Political Economy, University of Chicago Press, vol. 107(3), pages 507-538, June.
  2. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  3. Baxter, M. & Stockman, A.C., 1988. "Business Cycles And The Exchange Rate System: Some International Evidence," RCER Working Papers 140, University of Rochester - Center for Economic Research (RCER).
  4. McCallum, John, 1995. "National Borders Matter: Canada-U.S. Regional Trade Patterns," American Economic Review, American Economic Association, vol. 85(3), pages 615-23, June.
  5. Rogers, John H., 1999. "Monetary shocks and real exchange rates," Journal of International Economics, Elsevier, vol. 49(2), pages 269-288, December.
  6. Charles Engel & John H. Rogers, 1994. "How Wide is the Border?," NBER Working Papers 4829, National Bureau of Economic Research, Inc.
  7. Philippe Bacchetta & Eric van Wincoop, 1998. "Does Exchange Rate Stability Increase Trade and Capital Flows?," Working Papers 98.04, Swiss National Bank, Study Center Gerzensee.
  8. Obstfeld, M., 1998. "Risk and Exchange Rate," Papers 193, Princeton, Woodrow Wilson School - Public and International Affairs.
  9. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  10. Feenstra, Robert C. & Kendall, Jon D., 1997. "Pass-through of exchange rates and purchasing power parity," Journal of International Economics, Elsevier, vol. 43(1-2), pages 237-261, August.
  11. Jeffrey A. Frankel, 1993. "On Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061546, December.
  12. Rogers, John H. & Jenkins, Michael, 1995. "Haircuts or hysteresis? Sources of movements in real exchange rates," Journal of International Economics, Elsevier, vol. 38(3-4), pages 339-360, May.
  13. Charles Engel, 1999. "Local-Currency Pricing and the Choice of Exchange-Rate Regime," Working Papers 0036, University of Washington, Department of Economics.
  14. Backus, David K. & Smith, Gregor W., 1993. "Consumption and real exchange rates in dynamic economies with non-traded goods," Journal of International Economics, Elsevier, vol. 35(3-4), pages 297-316, November.
  15. Engel, Charles, 1993. "Real exchange rates and relative prices : An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 35-50, August.
  16. Harrigan, James, 1996. "Openness to trade in manufactures in the OECD," Journal of International Economics, Elsevier, vol. 40(1-2), pages 23-39, February.
  17. Isard, Peter, 1977. "How Far Can We Push the "Law of One Price"?," American Economic Review, American Economic Association, vol. 67(5), pages 942-48, December.
  18. Michael B. Devereux & Charles Engel, 1998. "Fixed vs. Floating Exchange Rates: How Price Setting Affects the Optimal Choice of Exchange-Rate Regime," NBER Working Papers 6867, National Bureau of Economic Research, Inc.
  19. John F. Helliwell, 1995. "Do National Borders Matter for Quebec's Trade?," NBER Working Papers 5215, National Bureau of Economic Research, Inc.
  20. Eric van Wincoop & Philippe Bacchetta, 2000. "Does Exchange-Rate Stability Increase Trade and Welfare?," American Economic Review, American Economic Association, vol. 90(5), pages 1093-1109, December.
  21. Baxter, Marianne & Stockman, Alan C., 1989. "Business cycles and the exchange-rate regime : Some international evidence," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 377-400, May.
  22. Maurice Obstfeld, 1997. "Europe's gamble," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(2), pages 241-317.
  23. Marston, Richard C., 1990. "Pricing to market in Japanese manufacturing," Journal of International Economics, Elsevier, vol. 29(3-4), pages 217-236, November.
  24. Giovannini, Alberto, 1988. "Exchange rates and traded goods prices," Journal of International Economics, Elsevier, vol. 24(1-2), pages 45-68, February.
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