Cross-country price dispersion in the euro era: a case study of the European car market[‘The Law of One Price in Scandinavian duty-free stores’]

IMPACT OF THE EUROThis paper investigates the effects of the European monetary union on cross-country price differences in the European car market. The analysis utilizes disaggregate, bi-annual data on the prices of almost all car models sold in the 15 countries of the European Union over 1993–2003. The data refer to identical models, with identical specifications and options. To identify the euro's effect, we exploit the fact that out of the 15 countries in our sample, 12 joined Euroland at the beginning of 1999 and officially adopted the euro as their national currency at the beginning of 2002, while 3 countries remained outside the monetary union. We investigate whether there is a systematic difference in the evolution of cross-country price dispersion between Euroland members and non-members after 1999. Our analysis distinguishes between Phase I (monetary union with national currencies preserved, 1999–2001) and Phase II (official adoption of the euro as a national currency in 2002). We examine the evolution of both the absolute price differentials across countries, and the speed with which deviations from the long-term cross-country differentials are eliminated.We find that in the pre-euro era, countries that later joined Euroland exhibited lower price differentials relative to the base country of the Netherlands, by approximately 6%. The monetary union further reduced these differentials by a small but significant percentage (about 1.5%) between 1999 and 2001; this reduction happened while the price differentials in non-Euroland countries increased. The price differentials in Euroland countries further decreased following the official euro adoption in 2002. However, we cannot attribute this decline to the euro, as we witness an even faster decrease of price differentials in non-Euroland countries over the 2002–2003 period. Despite these reductions, cross-country price differences remain large, even among members.Regarding the speed of convergence, we find that even before 1999 the half-life of price shocks was shorter in Euroland countries compared to non-Euroland countries (0.65 versus 1 year). However, we do not find any evidence that the EMU further affected the speed of convergence in a significant manner. Overall, our results suggest a big role for exchange rate stability in reducing international price dispersion and a smaller role for a common currency. The surprisingly high remaining international price differentials after the euro suggest the need for additional measures towards integration (e.g., liberalization of the distribution system, reduction of high registration taxes in particular countries).— Pinelopi Koujianou Goldberg and Frank Verboven