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A Price Based Approach To Estimate The Effects Of Monetary Arrangements On Trade Integration

Author

Listed:
  • David C. Parsley

    (Owen Graduate School of Management; Vanderbilt University)

  • Shang-Jin Wei

    (International Monetary Fund; NBER)

Abstract

A rapidly expanding literature studies the effect of currency union and other exchange rate arrangements on goods market integration. All existing studies employ a methodology based on observed volumes of trade. However, from a theoretical point of view the connection between market integration and the volume of trade is loose. In this paper, we propose a different metric of market integration, based on the dispersion of prices of identical products in different countries. This metric is motivated by the theory of arbitrage in the presence of transaction costs. We apply the methodology to a unique 3-dimensional data set that includes prices of 95 very disaggregated goods (e.g., light bulbs and toothpaste with fluoride) in 83 cities around the world from 1990 to 2000. We find that a currency board or a currency union generally provides a stimulus to goods market integration that goes far beyond merely reducing exchange rate volatility to zero. However, there are important exceptions. Long-term currency unions exhibit greater integration than more recent currency boards. All existing arrangements can improve their integration further relative to a U.S. benchmark.

Suggested Citation

  • David C. Parsley & Shang-Jin Wei, 2004. "A Price Based Approach To Estimate The Effects Of Monetary Arrangements On Trade Integration," Development Working Papers 185, Centro Studi Luca d'Agliano, University of Milano.
  • Handle: RePEc:csl:devewp:185
    as

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    File URL: http://www.dagliano.unimi.it/media/WP2004_185.pdf
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    References listed on IDEAS

    as
    1. 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.
    2. 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.
    3. Rose, Andrew K & Engel, Charles, 2002. "Currency Unions and International Integration," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(4), pages 1067-1089, November.
    4. 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 473-498, March.
    5. Torsten Persson, 2001. "Currency unions and trade: how large is the treatment effect?," Economic Policy, CEPR;CES;MSH, vol. 16(33), pages 433-462, October.
    6. 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.
    7. McCallum, John, 1995. "National Borders Matter: Canada-U.S. Regional Trade Patterns," American Economic Review, American Economic Association, vol. 85(3), pages 615-623, June.
    8. Parsley, David C. & Wei, Shang-Jin, 2001. "Explaining the border effect: the role of exchange rate variability, shipping costs, and geography," Journal of International Economics, Elsevier, vol. 55(1), pages 87-105, October.
    9. Jeffrey Frankel & Andrew Rose, 2002. "An Estimate of the Effect of Common Currencies on Trade and Income," The Quarterly Journal of Economics, Oxford University Press, vol. 117(2), pages 437-466.
    10. David C. Parsley & Shang-Jin Wei, 1996. "Convergence to the Law of One Price Without Trade Barriers or Currency Fluctuations," The Quarterly Journal of Economics, Oxford University Press, vol. 111(4), pages 1211-1236.
    11. 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.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    hard pegs; currency board; dollarization; market integration;

    JEL classification:

    • F3 - International Economics - - International Finance
    • F2 - International Economics - - International Factor Movements and International Business

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