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

Alex Nikolsko-Rzhevskyy and Olena Ogrokhina ()

Economic Modelling, 2018, vol. 69, issue C, 49-57

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.

Keywords: Price divergence; Common currency; Eurozone; Difference-in-differences (search for similar items in EconPapers)
JEL-codes: E31 F14 F15 F36 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1016/j.econmod.2017.09.005

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