A Re-Examination of the Border Effect

Abstract

This paper reexamines the evidence on the border effect, the finding that the border drives a wedge between domestic and foreign prices. We argue that the border effect can be inflated by the volatility and persistence of the nominal exchange rate and by the cross-country heterogeneity in the distribution of within-country price differentials. We develop a simple framework to separate the border effect from these confounding factors. Using price data from Engel and Rogers (1996) and Parsley and Wei (2001), we show that after controlling for the confounding factors the border effect between the U.S. and Canada and the U.S. and Japan is negligible.