Working Paper: CEPR ID: DP2958
Authors: David Parsley; Shangjin Wei
Abstract: 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 of 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 1990-2000. 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 US benchmark.
Keywords: currency union; dollarization; hard pegs; market integration
JEL Codes: F33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| instrumental stabilization of the exchange rate (F33) | goods market integration (F02) |
| distance (R12) | goods market integration (F02) |
| exchange rate variability (F31) | goods market integration (F02) |
| tariff barriers (F14) | goods market integration (F02) |
| institutional stabilization (E63) | goods market integration (F02) |
| institutional stabilization (E63) | instrumental stabilization (E63) |