The Price Impact of Joining a Currency Union: Evidence from Latvia
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. We consider the case of Latvia, which recently dropped its pegged exchange rate and joined the euro zone. We analyze 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 percent 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.
We thank Dennis Carlton and Raphael Schoenle for very helpful comments and suggestions. Diego Aparicio provided outstanding research assistance. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Alberto Cavallo has an ownership stake in PriceStats LLC, a private company that uses scraped online data to compute inflation indices.Roberto Rigobon
The author has an ownership stake in PriceStats LLC, a private company that uses scraped online data to compute inflation indices.
Alberto Cavallo & Brent Neiman & Roberto Rigobon, 2015. "The Price Impact of Joining a Currency Union: Evidence from Latvia," IMF Economic Review, Palgrave Macmillan, vol. 63(2), pages 281-297, September. citation courtesy of