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Deviations from Purchasing Power Parity:Causes and Welfare Costs

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  • Charles Engel
  • John H. Rogers

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

Paper provided by University of Washington, Department of Economics in its series Working Papers with number 0038.

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Date of creation: Jul 1999
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Handle: RePEc:udb:wpaper:0038

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  1. Philippe BACCHETTA & Eric VAN WINCOOP, 1999. "Does Exchange Rate Stability Increase Trade and Welfare ?," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP), Université de Lausanne, Faculté des HEC, DEEP 9917, Université de Lausanne, Faculté des HEC, DEEP.
  2. 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.
  3. Maurice Obstfeld, 1997. "Europe's gamble," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(2), pages 241-317.
  4. 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.
  5. Marston, Richard C., 1990. "Pricing to market in Japanese manufacturing," Journal of International Economics, Elsevier, vol. 29(3-4), pages 217-236, November.
  6. 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.
  7. Giovannini, Alberto, 1988. "Exchange rates and traded goods prices," Journal of International Economics, Elsevier, vol. 24(1-2), pages 45-68, February.
  8. Marianne Baxter & Alan C. Stockman, 1988. "Business Cycles and the Exchange Rate System: Some International Evidence," NBER Working Papers 2689, National Bureau of Economic Research, Inc.
  9. Bacchetta, Philippe & van Wincoop, Eric, 1998. "Does Exchange Rate Stability Increase Trade and Capital Flows?," CEPR Discussion Papers 1962, C.E.P.R. Discussion Papers.
  10. Charles Engel, 1992. "Real Exchange Rates and Relative Prices: An Empirical Investigation," NBER Working Papers 4231, National Bureau of Economic Research, Inc.
  11. 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.
  12. Feenstra, R.C. & Kendall, J.D., 1994. "Pass-Through of Exchange Rates and Purchasing Power Parity," Papers, Tasmania - Department of Economics 1994-06, Tasmania - Department of Economics.
  13. Charles Engel, 1999. "Local-Currency Pricing and the Choice of Exchange-Rate Regime," Working Papers, University of Washington, Department of Economics 0036, University of Washington, Department of Economics.
  14. Charles Engel, 1995. "Accounting for U.S. Real Exchange Rate Changes," NBER Working Papers 5394, National Bureau of Economic Research, Inc.
  15. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
  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. Maurice Obstfeld & Kenneth Rogoff, 1998. "Risk and Exchange Rates," NBER Working Papers 6694, National Bureau of Economic Research, Inc.
  18. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  19. John F. Helliwell, 1995. "Do National Borders Matter for Quebec's Trade?," NBER Working Papers 5215, National Bureau of Economic Research, Inc.
  20. 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.
  21. 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.
  22. Rogers, John H., 1999. "Monetary shocks and real exchange rates," Journal of International Economics, Elsevier, vol. 49(2), pages 269-288, December.
  23. Jeffrey A. Frankel, 1993. "On Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061546, December.
  24. Baxter, Marianne & Stockman, Alan C., 1989. "Business cycles and the exchange-rate regime : Some international evidence," Journal of Monetary Economics, Elsevier, Elsevier, vol. 23(3), pages 377-400, May.
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