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Europe Without Borders? The Effect of the EMU on Relative Prices

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Hisham Foad ()

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Abstract

Has the formation of the European Monetary Union reduced the impact of national borders on cross-border market convergence? This paper extends Engel and Rogers (1996) well known work on border effects to cities across Western Europe over the period 1995 . 2002 and finds two key results. First, cross-border relative prices tend to be more volatile than prices between locations not separated by a border. This result is robust to a variety of potential explanations for border effects, such as uneven sampling bias, idiosyncratic price shocks, and incomplete exchange rate-pass through. Turning our attention to cross-border price volatility before and after the formation of the EMU, the effects vary by country size. Within the EMU, cross-border price volatility has not changed between the "small" countries, but has fallen significantly between the large EMU countries. Between the EMU and the UK, cross-border volatility has increased between the UK and the small EMU countries, but there has been no significant change between the UK and the large EMU countries. These results are consistent with the fact that exchange rates are more likely to adjust to price differentials between small countries than between large countries.

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Paper provided by Department of Economics, Emory University (Atlanta) in its series Emory Economics with number 0515.

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Date of creation: Apr 2005
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Handle: RePEc:emo:wp2003:0515

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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.:
  1. Michael B. Devereux & Charles Engel & CÈdric Tille, 2003. "Exchange Rate Pass-Through and the Welfare Effects of the Euro," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(1), pages 223-242, February. [Downloadable!] (restricted)
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  2. Pesavento, Elena, 2004. "Analytical evaluation of the power of tests for the absence of cointegration," Journal of Econometrics, Elsevier, vol. 122(2), pages 349-384, October. [Downloadable!] (restricted)
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  3. Engel, Charles & Rogers, John H., 2001. "Deviations from purchasing power parity: causes and welfare costs," Journal of International Economics, Elsevier, vol. 55(1), pages 29-57, October. [Downloadable!] (restricted)
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  4. 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. [Downloadable!] (restricted)
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  5. Knetter, Michael M, 1989. "Price Discrimination by U.S. and German Exporters," American Economic Review, American Economic Association, vol. 79(1), pages 198-210, March. [Downloadable!] (restricted)
  6. Engel, Charles & Rogers, John H, 1996. "How Wide Is the Border?," American Economic Review, American Economic Association, vol. 86(5), pages 1112-25, December. [Downloadable!] (restricted)
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  7. Jenkins, Michael A, 1997. "Cities, Borders, Distances, Non-traded Goods and Purchasing Power Parity," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 59(2), pages 203-13, May.
  8. Giovannini, Alberto, 1988. "Exchange rates and traded goods prices," Journal of International Economics, Elsevier, vol. 24(1-2), pages 45-68, February. [Downloadable!] (restricted)
  9. 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. [Downloadable!] (restricted)
  10. John H. Rogers, 2001. "Price level convergence, relative prices, and inflation in Europe," International Finance Discussion Papers 699, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  11. Elliott, Graham & Rothenberg, Thomas J & Stock, James H, 1996. "Efficient Tests for an Autoregressive Unit Root," Econometrica, Econometric Society, vol. 64(4), pages 813-36, July. [Downloadable!] (restricted)
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  12. Charles Engel & John H. Rogers, 1998. "Relative Price Volatility: What Role Does the Border Play?," Discussion Papers in Economics at the University of Washington 0061, Department of Economics at the University of Washington. [Downloadable!]
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  13. Davis, Donald R, 1998. "The Home Market, Trade, and Industrial Structure," American Economic Review, American Economic Association, vol. 88(5), pages 1264-76, December. [Downloadable!] (restricted)
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  14. Taylor, Alan M, 2001. "Potential Pitfalls for the Purchasing-Power-Parity Puzzle? Sampling and Specification Biases in Mean-Reversion Tests of the Law of One Price," Econometrica, Econometric Society, vol. 69(2), pages 473-98, March.
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  15. 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. [Downloadable!] (restricted)
  16. Bergstrand, Jeffrey H, 1985. "The Gravity Equation in International Trade: Some Microeconomic Foundations and Empirical Evidence," The Review of Economics and Statistics, MIT Press, vol. 67(3), pages 474-81, August. [Downloadable!] (restricted)
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  1. Andrén, Niclas & Oxelheim, Lars, 2006. "Producer Prices in the Transition to a Common Currency," Working Paper Series 668, Research Institute of Industrial Economics. [Downloadable!]
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