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Deviations from purchasing power parity: causes and welfare costs

  • Charles Engel
  • John H. Rogers

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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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 666.

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Date of creation: 2000
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Handle: RePEc:fip:fedgif:666
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  1. Marston, Richard C., 1990. "Pricing to market in Japanese manufacturing," Journal of International Economics, Elsevier, vol. 29(3-4), pages 217-236, November.
  2. Philippe Bacchetta & Eric van Wincoop, 1998. "Does Exchange Rate Stability Increase Trade and Capital Flows?," Working Papers 98.04, Swiss National Bank, Study Center Gerzensee.
  3. Baxter, M. & Stockman, A.C., 1988. "Business Cycles And The Exchange Rate System: Some International Evidence," RCER Working Papers 140, University of Rochester - Center for Economic Research (RCER).
  4. Charles Engel, 1999. "Local-Currency Pricing and the Choice of Exchange-Rate Regime," Discussion Papers in Economics at the University of Washington 0036, Department of Economics at the University of Washington.
  5. Charles Engel, 1995. "Accounting for U.S. Real Exchange Rate Changes," NBER Working Papers 5394, National Bureau of Economic Research, Inc.
  6. Rogers, J.H. & Jenkins, M.A., 1993. "Haircuts or Hysteresis? Sources of Movements in Real Exchange Rates," Papers 4-93-6, Pennsylvania State - Department of Economics.
  7. Eric van Wincoop & Philippe Bacchetta, 2000. "Does Exchange-Rate Stability Increase Trade and Welfare?," American Economic Review, American Economic Association, vol. 90(5), pages 1093-1109, December.
  8. Jeffrey A. Frankel, 1993. "On Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061546, June.
  9. John H. Rogers, 1998. "Monetary shocks and real exchange rates," International Finance Discussion Papers 612, Board of Governors of the Federal Reserve System (U.S.).
  10. 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.
  11. Engel, C. & Rogers, J.H., 1995. "How Wide is the Border?," Papers 4-95-16, Pennsylvania State - Department of Economics.
  12. Engel, Charles, 1993. "Real exchange rates and relative prices : An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 35-50, August.
  13. John F. Helliwell, 1995. "Do National Borders Matter for Quebec's Trade?," NBER Working Papers 5215, National Bureau of Economic Research, Inc.
  14. Feenstra, Robert C. & Kendall, Jon D., 1997. "Pass-through of exchange rates and purchasing power parity," Journal of International Economics, Elsevier, vol. 43(1-2), pages 237-261, August.
  15. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  16. 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.
  17. Harrigan, James, 1996. "Openness to trade in manufactures in the OECD," Journal of International Economics, Elsevier, vol. 40(1-2), pages 23-39, February.
  18. Obstfeld, M., 1998. "Risk and Exchange Rate," Papers 193, Princeton, Woodrow Wilson School - Public and International Affairs.
  19. 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.
  20. Maurice Obstfeld, 1997. "Europe's gamble," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(2), pages 241-317.
  21. Giovannini, Alberto, 1988. "Exchange rates and traded goods prices," Journal of International Economics, Elsevier, vol. 24(1-2), pages 45-68, February.
  22. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  23. Baxter, Marianne & Stockman, Alan C., 1989. "Business cycles and the exchange-rate regime : Some international evidence," Journal of Monetary Economics, Elsevier, vol. 23(3), pages 377-400, May.
  24. 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.
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