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The impact of monetary union on trade prices

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  • Taglioni, Daria
  • Anderton, Robert
  • Baldwin, Richard E.

Abstract

Two seemingly unconnected empirical results suggest an intriguing mechanism. First, economic integration helps harmonize prices internationally, with trade being the primary channel (Rogoff 1996, Goldberg and Knetter 1997). Second, monetary union may greatly increase the amount of trade among members (Rose 2001). Putting these together, we see that formation of a monetary union may induce changes that help harmonise inflation rates. The effect might be large if the elimination of exchange rate volatility simultaneously leads to a large increase in intra-union trade and a big increase in the speed at which price shocks are transmitted across members' goods markets. This paper investigates part of this mechanism and finds that monetary union may indeed result in faster cross-border transmission of price movements via the import and export price channel which, in turn, would tend to homogenise price movements across the member countries of a monetary union. JEL Classification: D40, F15, F31

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 0238.

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Date of creation: Jun 2003
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Handle: RePEc:ecb:ecbwps:20030238

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Keywords: Exchange rate volatility; harmonisation of price movements; market segmentation; monetary union; no-arbitrage bands;

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  1. Mark P. Taylor, 2003. "Purchasing Power Parity," Review of International Economics, Wiley Blackwell, vol. 11(3), pages 436-452, 08.
  2. Obstfeld, Maurice & Taylor, Alan M., 1997. "Nonlinear Aspects of Goods-Market Arbitrage and Adjustment: Heckscher's Commodity Points Revisited," Journal of the Japanese and International Economies, Elsevier, vol. 11(4), pages 441-479, December.
  3. David C. Parsley & Shang-Jin Wei, 2001. "Limiting Currency Volatility to Stimulate Goods Market Integration: A Price Based Approach," NBER Working Papers 8468, National Bureau of Economic Research, Inc.
  4. Enders, Walter & Granger, Clive W J, 1998. "Unit-Root Tests and Asymmetric Adjustment with an Example Using the Term Structure of Interest Rates," Journal of Business & Economic Statistics, American Statistical Association, vol. 16(3), pages 304-11, July.
  5. Nickell, Stephen J, 1981. "Biases in Dynamic Models with Fixed Effects," Econometrica, Econometric Society, vol. 49(6), pages 1417-26, November.
  6. Friberg, Richard, 2001. "Two monies, two markets?: Variability and the option to segment," Journal of International Economics, Elsevier, vol. 55(2), pages 317-327, December.
  7. Richard Baldwin & Paul R. Krugman, 1986. "Persistent Trade Effects of Large Exchage Rate Shocks," NBER Working Papers 2017, National Bureau of Economic Research, Inc.
  8. Andrew K. Rose, 1999. "One Money, One Market: Estimating the Effect of Common Currencies on Trade," NBER Working Papers 7432, National Bureau of Economic Research, Inc.
  9. Taylor, Mark P & Peel, David A & Sarno, Lucio, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Toward a Solution to the Purchasing Power Parity Puzzles," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 42(4), pages 1015-42, November.
  10. Pinelopi Koujianou Goldberg & Michael M. Knetter, 1997. "Goods Prices and Exchange Rates: What Have We Learned?," Journal of Economic Literature, American Economic Association, vol. 35(3), pages 1243-1272, September.
  11. Shin, Dong Wan & Lee, Oesook, 2001. "Tests for Asymmetry in Possibly Nonstationary Time Series Data," Journal of Business & Economic Statistics, American Statistical Association, vol. 19(2), pages 233-44, April.
  12. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  13. Marcus Asplund & Richard Friberg, 2001. "The Law of One Price in Scandinavian Duty-Free Stores," American Economic Review, American Economic Association, vol. 91(4), pages 1072-1083, September.
  14. Dixit, Avinash K, 1989. "Hysteresis, Import Penetration, and Exchange Rate Pass-Through," The Quarterly Journal of Economics, MIT Press, vol. 104(2), pages 205-28, May.
  15. Bruce E. Hansen & Mehmet Caner, 1997. "Threshold Autoregressions with a Unit Root," Boston College Working Papers in Economics 381, Boston College Department of Economics.
  16. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  17. Baldwin, Richard, 1988. "Hyteresis in Import Prices: The Beachhead Effect," American Economic Review, American Economic Association, vol. 78(4), pages 773-85, September.
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Citations

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Cited by:
  1. Ascari, Guido & Rankin, Neil, 2007. "Perpetual youth and endogenous labor supply: A problem and a possible solution," Journal of Macroeconomics, Elsevier, vol. 29(4), pages 708-723, December.
  2. Isabelle Méjean & Cyrille Schwellnus, 2009. "Price Convergence in the European Union: Within Firms or Composition of Firms?," Working Papers 2009-03, CEPII research center.
  3. Richard Baldwin Virginia Di Nino, 2006. "Euros and zeros: The common currency effect on trade in new goods," IHEID Working Papers 21-2006, Economics Section, The Graduate Institute of International Studies, revised 31 Oct 2006.
  4. Philipp Maier, 2005. "A `Global Village' without borders? International price differentials at eBay," DNB Working Papers 044, Netherlands Central Bank, Research Department.
  5. Marco G. Ercolani & Jayasri Dutta, 2006. "The Euro-changeoverand Euro-inflation: Evidence from Eurostat's HICP," Discussion Papers 06-03, Department of Economics, University of Birmingham.
  6. Philipp Maier, 2004. "EMU enlargement, inflation and adjustment of tradable goods prices: What to expect?," DNB Working Papers 010, Netherlands Central Bank, Research Department.

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