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The Impact of Monetary Union on Trade Prices

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Author Info
Anderton, Robert (European Central Bank)
Richard E Baldwin
Daria Taglioni

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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. The problem is that standard estimates of price transmission speed suggest that trade's price-homogenising effect operates too slowly to matter much. Some new empirical evidence, however, suggests that a reduction in exchange rate variability reduces the variability of international price differences. Moreover, the effect seems to be highly nonlinear, and monetary union seems to have an effect even controlling for exchange rate volatility. This paper is a first attempt to piece together part of this mechanism, namely the impact of monetary union (and exchange rate volatility more generally) on the international transmission of price shocks via the imported/exported inflation channel. In doing this we generate specific testable hypotheses and confront these with a number of data sets on European trade prices.

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Paper provided by Royal Economic Society in its series Royal Economic Society Annual Conference 2003 with number 5.

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Date of creation: 04 Jun 2003
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Handle: RePEc:ecj:ac2003:5

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Related research
Keywords: price arbitrage; exchange rate volatility; monetary union; market segmentation; non-linearities; no-arbitrage bands; harmonisation of price movements;

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Find related papers by JEL classification:
D40 - Microeconomics - - Market Structure and Pricing - - - General
F15 - International Economics - - Trade - - - Economic Integration
F31 - International Economics - - International Finance - - - Foreign Exchange

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  3. 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. [Downloadable!] (restricted)
  4. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June. [Downloadable!] (restricted)
  5. 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.
  6. Bruce E. Hansen & Mehmet Caner, 1997. "Threshold Autoregressions with a Unit Root," Boston College Working Papers in Economics 381, Boston College Department of Economics. [Downloadable!]
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  7. Rose, Andrew K, 1999. "One Money, One Market: Estimating the Effect of Common Currencies on Trade," CEPR Discussion Papers 2329, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  8. 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. [Downloadable!] (restricted)
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  9. 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. [Downloadable!] (restricted)
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  10. Richard Baldwin, 1988. "Hysteresis In Import Prices: The Beachhead Effect," NBER Working Papers 2545, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Mark P. Taylor, 2003. "Purchasing Power Parity," Review of International Economics, Blackwell Publishing, vol. 11(3), pages 436-452, 08. [Downloadable!] (restricted)
  12. 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.
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  13. 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. [Downloadable!] (restricted)
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  14. Maurice Obstfeld & Alan M. Taylor, 1997. "Nonlinear Aspects of Goods-Market Arbitrage and Adjustment: Heckscher's Commodity Points Revisited," NBER Working Papers 6053, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  15. Nickell, Stephen J, 1981. "Biases in Dynamic Models with Fixed Effects," Econometrica, Econometric Society, vol. 49(6), pages 1417-26, November. [Downloadable!] (restricted)
  16. Peel, David & Sarno, Lucio & Taylor, Mark P, 2001. "Nonlinear Mean-Reversion in Real Exchange Rates: Towards a Solution to the Purchasing Power Parity Puzzles," CEPR Discussion Papers 2658, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  17. 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. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Baldwin, Richard & Di Nino, Virginia, 2006. "Euros and Zeros: The Common Currency Effect on Trade in New Goods," CEPR Discussion Papers 5973, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  2. Marco G. Ercolani and Jayasri Dutta, 2006. "The Euro-changeoverand Euro-inflation: Evidence from Eurostat's HICP," Discussion Papers 06-03, Department of Economics, University of Birmingham. [Downloadable!]
  3. Philipp Maier, 2005. "A `Global Village' without borders? International price differentials at eBay," DNB Working Papers 044, Netherlands Central Bank, Research Department. [Downloadable!]
    Other versions:
  4. Philipp Maier, 2004. "EMU enlargement, inflation and adjustment of tradable goods prices: What to expect?," DNB Working Papers 010, Netherlands Central Bank, Research Department. [Downloadable!]
  5. Isabelle Méjean & Cyrille Schwellnus, 2009. "Price Convergence in the European Union: Within Firms or Composition of Firms?," Working Papers hal-00354190_v1, HAL. [Downloadable!]
    Other versions:
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