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Behavior of retail prices in common currency areas: The case of the Eurozone

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  • Nikolsko-Rzhevskyy, Alex
  • Ogrokhina, Olena

Abstract

Does a common currency lead to price convergence? In this paper we both theoretically and empirically show that the effect of a common currency is ambiguous. First, we extend the Ganslandt and Maskus (2007) model of vertical pricing with parallel trade. Our innovation is to consider both domestic trade, where trading costs are relatively low, and international trade, where trading costs are relatively high. If trading costs decline, the model predicts price divergence in the former case, and price convergence in the latter case. Second, using the introduction of the euro as a natural experiment that reduced trading costs, we employ difference-in-differences estimation strategy to test the model's predictions. Our results show that while individual goods prices between countries converged by 2%, within-country prices diverged by 4%, supporting the predictions of our model.

Suggested Citation

  • Nikolsko-Rzhevskyy, Alex & Ogrokhina, Olena, 2018. "Behavior of retail prices in common currency areas: The case of the Eurozone," Economic Modelling, Elsevier, vol. 69(C), pages 49-57.
    • Handle: RePEc:eee:ecmode:v:69:y:2018:i:c:p:49-57
    DOI: 10.1016/j.econmod.2017.09.005
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    References listed on IDEAS

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    Cited by:

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    4. Crucini, Mario J. & Yilmazkuday, Hakan, 2014. "Understanding long-run price dispersion," Journal of Monetary Economics, Elsevier, vol. 66(C), pages 226-240.

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    More about this item

    Keywords

    Price divergence; Common currency; Eurozone; Difference-in-differences;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • F14 - International Economics - - Trade - - - Empirical Studies of Trade
    • F15 - International Economics - - Trade - - - Economic Integration
    • F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration

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