Working Paper: NBER ID: w20225
Authors: Alberto Cavallo; Brent Neiman; Roberto Rigobon
Abstract: 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.
Keywords: currency union; relative prices; Latvia; euro zone; price convergence
JEL Codes: E3; F3; F4
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Latvia's entry into the euro zone (F36) | price equalization across borders (F61) |
| Latvia's entry into the euro zone (F36) | reduction in price dispersion (D40) |
| many firms adopting similar pricing strategies (L11) | overall effect of currency union membership on the real exchange rate (F36) |