Monetary Union, Price Level Convergence, and Inflation: How Close is Europe to the United States?

51 Pages Posted: 19 Dec 2002

See all articles by John H. Rogers

John H. Rogers

Board of Governors of the Federal Reserve System - Trade and Financial Studies Section

Date Written: October 2002

Abstract

In light of 50 years of economic policies designed to integrate Europe - culminating in the elimination of euro zone national currencies in early 2002 - and a vast academic literature on international economic integration, it is of interest to assess how far European integration has come in practice. Using a unique data set, I document the pattern of price dispersion across European and U.S. cities from 1990 to 2001. I find a striking decline in dispersion for traded goods prices in Europe, most of which took place between 1991 and 1994. The level of traded goods price dispersion in the euro area is now quite close to that of the United States. A decline in dispersion of non-tradeables prices in Europe has also taken place, but to a smaller extent. For U.S. cities, there is no evidence of a decline in price dispersion, even for tradeables. I examine several possible explanations for the decline in European price dispersion, including harmonization of tax rates, convergence of incomes and labor costs, liberalization of trade and factor markets, and increased coherence of monetary policy. I also investigate how much of the variation in national inflation rates in Europe can be explained by price level convergence. Finally, after showing that prices in likely next-round entrants into the euro zone are well below prices in Western Europe, I discuss the potential inflationary consequences of accession into monetary union for Eastern Europe.

Keywords: economic integration, prices, exchange rates, euro

JEL Classification: E31, F36, F41

Suggested Citation

Rogers, John H., Monetary Union, Price Level Convergence, and Inflation: How Close is Europe to the United States? (October 2002). FRB International Finance Discussion Paper No. 740. Available at SSRN: https://ssrn.com/abstract=345160 or http://dx.doi.org/10.2139/ssrn.345160

John H. Rogers (Contact Author)

Board of Governors of the Federal Reserve System - Trade and Financial Studies Section ( email )

20th St. and Constitution Ave.
Washington, DC 20551
United States
202-452-2873 (Phone)
202-736-5638 (Fax)

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