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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 Department of Economics at the University of Washington in its series Discussion Papers in Economics at the University of Washington with number 0038.

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Date of creation: Jul 1999
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Handle: RePEc:fth:washer: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) 9917, Université de Lausanne, Faculté des HEC, DEEP.
  2. 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.
  3. Kenneth Rogoff, 1996. "The Purchasing Power Parity Puzzle," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 647-668, June.
  4. John F. Helliwell, 1996. "Do National Borders Matter for Quebec's Trade?," Canadian Journal of Economics, Canadian Economics Association, vol. 29(3), pages 507-22, August.
  5. Engel, Charles, 1993. "Real exchange rates and relative prices : An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 35-50, August.
  6. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, June.
  7. Jeffrey A. Frankel, 1993. "On Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061546, June.
  8. Charles Engel, 1995. "Accounting for U.S. Real Exchange Rate Changes," NBER Working Papers 5394, National Bureau of Economic Research, Inc.
  9. Rogers, John H., 1999. "Monetary shocks and real exchange rates," Journal of International Economics, Elsevier, vol. 49(2), pages 269-288, December.
  10. 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.
  11. Engel, Charles & Rogers, John H, 1996. "How Wide Is the Border?," American Economic Review, American Economic Association, vol. 86(5), pages 1112-25, December.
  12. David K. Backus & Gregor W. Smith, 1993. "Consumption and Real Exchange Rates in Dynamic Economies with Non-Traded Goods," Working Papers 1252, Queen's University, Department of Economics.
  13. Harrigan, James, 1996. "Openness to trade in manufactures in the OECD," Journal of International Economics, Elsevier, vol. 40(1-2), pages 23-39, February.
  14. 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.
  15. 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).
  16. 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.
  17. Giovannini, Alberto, 1988. "Exchange rates and traded goods prices," Journal of International Economics, Elsevier, vol. 24(1-2), pages 45-68, February.
  18. Engel, Charles, 2000. "Local-currency pricing and the choice of exchange-rate regime," European Economic Review, Elsevier, vol. 44(8), pages 1449-1472, August.
  19. Obstfeld, M., 1998. "Risk and Exchange Rate," Papers 193, Princeton, Woodrow Wilson School - Public and International Affairs.
  20. Marston, Richard C., 1990. "Pricing to market in Japanese manufacturing," Journal of International Economics, Elsevier, vol. 29(3-4), pages 217-236, November.
  21. Maurice Obstfeld, 1997. "Europe's gamble," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 28(2), pages 241-317.
  22. Feenstra, R.C. & Kendall, J.D., 1994. "Pass-Through of Exchange Rates and Purchasing Power Parity," Papers 1994-06, Tasmania - Department of Economics.
  23. 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.
  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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