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The Law of One Price Without the Border: The Role of Distance Versus Sticky Prices

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  • Mario J. Crucini
  • Mototsugu Shintani
  • Takayuki Tsuruga

Abstract

We examine the role of nominal price rigidities in explaining the deviations from the Law of One Price (LOP) across cities in Japan. Focusing on intra-national relative prices isolates the border effect and thus enables us to extract the pure effect of sticky prices. A two-city model with nominal rigidities and transportation costs predicts that the variation of LOP deviations is lower for goods with less frequent price adjustment after controlling for the distance separating the cities. Using retail price data for individual goods and services collected in Japanese cities, we find strong evidence supporting this prediction. Adapting the Engel and Rogers (1996) regression framework to our theoretical setting, we quantify the separate roles of nominal rigidities and trade costs (proxied by distance) in generating LOP variability. Our estimates suggest that the distance equivalent of nominal rigidities can be as large as the `width' of the border typically found in the literature on international LOP deviations. The findings point to both the utility of the regression framework in identifying qualitative effects (i.e., sign of a coefficient) and the challenges interpreting their quantitative implications.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14835.

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Date of creation: Apr 2009
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Publication status: published as MarioJ. Crucini & Mototsugu Shintani & Takayuki Tsuruga, 2010. "The Law of One Price without the Border: The Role of Distance versus Sticky Prices," Economic Journal, Royal Economic Society, vol. 120(544), pages 462-480, 05.
Handle: RePEc:nbr:nberwo:14835

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  1. Goldberg, Pinelopi & Verboven, Frank, 2001. "Market Integration and Convergence to the Law of One Price: Evidence from the European Car Market," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2926, C.E.P.R. Discussion Papers.
  2. Crucini, Mario J. & Shintani, Mototsugu, 2008. "Persistence in law of one price deviations: Evidence from micro-data," Journal of Monetary Economics, Elsevier, Elsevier, vol. 55(3), pages 629-644, April.
  3. Emi Nakamura & Jón Steinsson, 2008. "Five Facts about Prices: A Reevaluation of Menu Cost Models," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 123(4), pages 1415-1464, November.
  4. V.V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1998. "Can sticky price models generate volatile and persistent real exchange rates?," Staff Report, Federal Reserve Bank of Minneapolis 223, Federal Reserve Bank of Minneapolis.
  5. Charles Engel & John H. Rogers, 1995. "How wide is the border?," Research Working Paper, Federal Reserve Bank of Kansas City 95-09, Federal Reserve Bank of Kansas City.
  6. Mario J. Crucini & Mototsugu Shintani & Takayuki Tsuruga, 2008. "Accounting for persistence and volatility of good-level real exchange rates: the role of sticky information," Globalization and Monetary Policy Institute Working Paper, Federal Reserve Bank of Dallas 07, Federal Reserve Bank of Dallas.
  7. Choi, Chi-Young & Matsubara, Kiyoshi, 2007. "Heterogeneity in the persistence of relative prices: What do the Japanese cities tell us?," Journal of the Japanese and International Economies, Elsevier, vol. 21(2), pages 260-286, June.
  8. Calvo, Guillermo A., 1983. "Staggered prices in a utility-maximizing framework," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(3), pages 383-398, September.
  9. Robert Feenstra & Paul Bergin, 2003. "Pricing To Market, Staggered Contracts, And Real Exchange Rate Persistence," Working Papers, University of California, Davis, Department of Economics 991, University of California, Davis, Department of Economics.
  10. Peter J. Klenow & Oleksiy Kryvtsov, 2005. "State-Dependent or Time-Dependent Pricing: Does it Matter for Recent U.S. Inflation?," NBER Working Papers 11043, National Bureau of Economic Research, Inc.
  11. Mark Bils & Peter J. Klenow, 2004. "Some Evidence on the Importance of Sticky Prices," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 112(5), pages 947-985, October.
  12. Mario J. Crucini & Chris I. Telmer & Marios Zachariadis, 2005. "Understanding European Real Exchange Rates," American Economic Review, American Economic Association, American Economic Association, vol. 95(3), pages 724-738, June.
  13. Yin-Wong Cheung & Eiji Fujii, 2008. "Deviations from the Law of One Price in Japan," CESifo Working Paper Series 2275, CESifo Group Munich.
  14. Patrick J. Kehoe & Virgiliu Midrigan, 2007. "Sticky prices and sectoral real exchange rates," Working Papers, Federal Reserve Bank of Minneapolis 656, Federal Reserve Bank of Minneapolis.
  15. David C. Parsley & Shang-Jin Wei, 1996. "Convergence to the Law of One Price Without Trade Barriers or Currency Fluctuations," NBER Working Papers 5654, National Bureau of Economic Research, Inc.
  16. Christian Broda & David E. Weinstein, 2008. "Understanding International Price Differences Using Barcode Data," NBER Working Papers 14017, National Bureau of Economic Research, Inc.
  17. Baba, Chikako, 2007. "Price dispersion across and within countries: The case of Japan and Korea," Journal of the Japanese and International Economies, Elsevier, vol. 21(2), pages 237-259, June.
  18. Janet Ceglowski, 2003. "The law of one price: intranational evidence for Canada," Canadian Journal of Economics, Canadian Economics Association, Canadian Economics Association, vol. 36(2), pages 373-400, May.
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