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The Price Impact of Joining a Currency Union: Evidence from Latvia

17 Pages Posted: 21 Aug 2015  

Alberto Cavallo

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Brent Neiman

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: September 2015

Abstract

Does membership in a currency union matter for a country’s international relative prices? The answer to this question is critical for thinking about the implications of joining (or exiting) a common currency area. This paper is the first to use high-frequency good-level data to provide evidence that the answer is yes, at least for an important subset of consumption goods. It considers the case of Latvia, which recently dropped its pegged exchange rate and joined the euro zone. The paper analyzes the prices of thousands of differentiated goods sold by Zara, the world’s largest clothing retailer. Price dispersion between Latvia and euro zone countries collapsed swiftly following entry to the euro. The percentage of goods with nearly identical prices in Latvia and Germany increased from 6 to 89 percent. The median size of price differentials declined from 7 percent to zero. If a large number of firms also behave this way, these results suggest that membership in a currency union has significant implications for a country’s real exchange rate.

Suggested Citation

Cavallo, Alberto and Neiman, Brent and Rigobon, Roberto, The Price Impact of Joining a Currency Union: Evidence from Latvia (September 2015). IMF Economic Review, Vol. 63, Issue 2, pp. 281-297, 2015. Available at SSRN: https://ssrn.com/abstract=2648941 or http://dx.doi.org/10.1057/imfer.2015.13

Alberto Cavallo (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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Brent Neiman

University of Chicago - Booth School of Business ( email )

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Chicago, IL 60637
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HOME PAGE: http://faculty.chicagobooth.edu/brent.neiman/index.html

National Bureau of Economic Research (NBER) ( email )

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Roberto Rigobon

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

E52-447
Cambridge, MA 02142
United States
617-258-8374 (Phone)
617-258-6855 (Fax)

National Bureau of Economic Research (NBER) ( email )

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Cambridge, MA 02138
United States

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