Limiting Currency Volatility to Stimulate Goods Market Integration: A Price Based Approach

David C. Parsley, Shang-Jin Wei

NBER Working Paper No. 8468
Issued in September 2001
NBER Program(s):International Finance and Macroeconomics, International Trade and Investment

This paper empirically studies the effect of instrumental and institutional stabilization of the exchange rate on the integration of goods markets. An instrumental stabilization of the exchange rate is accomplished through intervention in the foreign exchange market, or by monetary policies. An institutional stabilization, is an adoption a currency board or a common currency. In contrast to the literature that employs data on the volume of trade, an important novelty of this paper is the use of a 3-dimensional panel of prices of 95 very disaggregated goods (e.g., light bulbs) in 83 cities from around the world from 1990 to 2000. We find that goods market integration is increasing over time and is inversely related to distance, exchange rate variability, and tariff barriers. In addition, the impact of an institutional stabilization of the exchange rate provides a stimulus to goods market integration that goes far beyond an instrumental stabilization. Among the institutional arrangements, long-term currency unions demonstrate greater integration than more recent currency boards. All of them can improve their integration further relative to a U.S. benchmark.

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Document Object Identifier (DOI): 10.3386/w8468

Published: David C. Parsley & Shang-Jin Wei, 2001. "Limiting Currency Volatility to Stimulate Goods Market Integration: A Price-Based Approach," IMF Working Papers, vol 01(197).

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