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Limiting Currency Volatility to Stimulate Goods Market Integration: a Price-Based Approach

  • Parsley, David
  • Wei, Shang-Jin

This Paper empirically studies the effect of instrumental and institutional stabilization of the exchange rate on the integration of goods markets. An instrumental stabilization of the exchange rate is accomplished through intervention in the foreign exchange market, or by monetary policies. An institutional stabilization is an adoption of a currency board or a common currency. In contrast to the literature that employs data on the volume of trade, an important novelty of this Paper is the use of a 3-dimensional panel of prices of 95 very disaggregated goods (e.g., light bulbs) in 83 cities from around the world from 1990-2000. We find that goods market integration is increasing over time and is inversely related to distance, exchange rate variability, and tariff barriers. In addition, the impact of an institutional stabilization of the exchange rate provides a stimulus to goods market integration that goes far beyond an instrumental stabilization. Among the institutional arrangements, long-term currency unions demonstrate greater integration than more recent currency boards. All of them can improve their integration further relative to a US benchmark.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2958.

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Date of creation: Sep 2001
Date of revision:
Handle: RePEc:cpr:ceprdp:2958
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  1. Martin Feldstein, 1997. "The Political Economy of the European Economic and Monetary Union: Political Sources of an Economic Liability," Journal of Economic Perspectives, American Economic Association, vol. 11(4), pages 23-42, Fall.
  2. 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.).
  3. Engel, C., 1996. "Accounting for U.S. Real Exchange Rate Changes," Working Papers 96-02, University of Washington, Department of Economics.
  4. 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.
  5. repec:tpr:qjecon:v:111:y:1996:i:4:p:1211-36 is not listed on IDEAS
  6. Mussa, Michael, 1986. "Nominal exchange rate regimes and the behavior of real exchange rates: Evidence and implications," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 25(1), pages 117-214, January.
  7. Engel, Charles & Rogers, John H, 1996. "How Wide Is the Border?," American Economic Review, American Economic Association, vol. 86(5), pages 1112-25, December.
  8. repec:oup:qjecon:v:111:y:1996:i:4:p:1211-36 is not listed on IDEAS
  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.
  10. Richardson, J. David, 1978. "Some empirical evidence on commodity arbitrage and the law of one price," Journal of International Economics, Elsevier, vol. 8(2), pages 341-351, May.
  11. Paul G. J. O'Connell & Shang-Jin Wei, 1997. ""The Bigger They Are, The Harder They Fall": How Price Differences Across U.S. Cities Are Arbitraged," NBER Working Papers 6089, National Bureau of Economic Research, Inc.
  12. Shang-Jin Wei, 1996. "Intra-National versus International Trade: How Stubborn are Nations in Global Integration?," NBER Working Papers 5531, National Bureau of Economic Research, Inc.
  13. Andrew K. Rose & Charles Engel, 2000. "Currency Unions and International Integration," NBER Working Papers 7872, National Bureau of Economic Research, Inc.
  14. Jeffrey A. Frankel & Andrew K. Rose, 2000. "Estimating the Effect of Currency Unions on Trade and Output," NBER Working Papers 7857, National Bureau of Economic Research, Inc.
  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.
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