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Regional Patterns in the Law of One Price: The Roles of Geography vs. Currencies

  • Charles Engel
  • John H. Rogers

We find evidence that the law of one price (LOOP) holds more nearly for country pairs that are within geographic regions than for country pairs that are not. These findings are established using disaggregated consumer price data from 23 countries (including data from eight North American cities). We find that failures of LOOP are closely related to nominal exchange rate variability, suggesting a link to sticky nominal prices. We also find that distance can explain failures of LOOP, suggesting the failures arise from imperfect market integration. However, these two sources do not explain all of the failure of LOOP. We speculate that integrated marketing and distribution systems within regions cause LOOP to hold more nearly intraregionally. We present a formal model of marketing and distribution to illustrate this hypothesis.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5395.

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Date of creation: Dec 1995
Date of revision:
Publication status: published as Frankel, Jeffrey A. (ed.) Regionalization of the World Economy. Chicago: University of Chicago Press, 1998.
Handle: RePEc:nbr:nberwo:5395
Contact details of provider: Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
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  1. Engel, Charles & Rogers, John H, 1996. "How Wide Is the Border?," American Economic Review, American Economic Association, vol. 86(5), pages 1112-25, December.
  2. 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.
  3. Shang-Jin Wei & David C. Parsley, 1995. "Purchasing Power Disparity During the Floating Rate Period: Exchange Rate Volatility, Trade Barriers and Other Culprits," NBER Working Papers 5032, National Bureau of Economic Research, Inc.
  4. 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.
  5. Kenneth A. Froot & Paul Klemperer, 1988. "Exchange Rate Pass-Through When Market Share Matters," NBER Working Papers 2542, National Bureau of Economic Research, Inc.
  6. Atish R. Ghosh & Holger C. Wolf, 1994. "Pricing in International Markets: Lessons From The Economist," NBER Working Papers 4806, National Bureau of Economic Research, Inc.
  7. Jeffrey A. Frankel, 1993. "On Exchange Rates," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061546, June.
  8. Frankel, Jeffrey & Stein, Ernesto & Wei, Shang-jin, 1995. "Trading blocs and the Americas: The natural, the unnatural, and the super-natural," Journal of Development Economics, Elsevier, vol. 47(1), pages 61-95, June.
  9. Engel, Charles, 1993. "Real exchange rates and relative prices : An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 32(1), pages 35-50, August.
  10. Froot, Kenneth A. & Kim, Michael & Rogoff, Kenneth, 1995. "The Law of One Price Over 700 Years," Working Papers 95-13, C.V. Starr Center for Applied Economics, New York University.
  11. Jong-Wha Lee & Phillip Swagel, 2000. "Trade Barriers And Trade Flows Across Countries And Industries," The Review of Economics and Statistics, MIT Press, vol. 79(3), pages 372-382, August.
  12. 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.
  13. Dornbusch, Rudiger, 1987. "Exchange Rates and Prices," American Economic Review, American Economic Association, vol. 77(1), pages 93-106, March.
  14. Mankiw, N Gregory, 1985. "Small Menu Costs and Large Business Cycles: A Macroeconomic Model," The Quarterly Journal of Economics, MIT Press, vol. 100(2), pages 529-38, May.
  15. Michael M. Knetter, 1994. "Why are Retail Prices in Japan so High?: Evidence from German Export Prices," NBER Working Papers 4894, National Bureau of Economic Research, Inc.
  16. Sanyal, Kalyan K & Jones, Ronald W, 1982. "The Theory of Trade in Middle Products," American Economic Review, American Economic Association, vol. 72(1), pages 16-31, March.
  17. Paul Krugman, 1986. "Pricing to Market when the Exchange Rate Changes," NBER Working Papers 1926, National Bureau of Economic Research, Inc.
  18. Sven W. Arndt & J. David Richardson, 1987. "Real-Financial Linkages Among Open Economies," NBER Working Papers 2230, National Bureau of Economic Research, Inc.
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