We study good-by-good deviations from the Law-of-One-Price for over 5,000 goods and services between European Union countries for the years 1975, 1980, 1985 and 1990. We …nd that between most countries there are roughly as many overpriced goods as there are underpriced goods. Equally-weighted and CPI-weighted averages of good-by-good relative prices generate relatively accurate predictions of most nominal cross-rates, as purchasing power parity (PPP) would suggest. These …ndings are robust across years, in spite of relatively large movements in nominal exchange rates. Variation around the averages is large but is found to be related to economically meaningful characteristics of goods such as international tradeability, non-tradedness of factors of production and the competitive structure of the markets in which the goods are sold. Using data on product brands, we …nd that product heterogeneity is at least as important as geography in explaining relative price dispersion. Overall, our data provide strong evidence that international goods markets are segmented, but (i) the evidence relies on absolute deviations from the Law-of-One-Price, not deviations from PPP, (ii) some markets are much more segmented than others, with the distinctions being consistent with economic theory.
We study the dynamics of good-by-good real exchange rates using a micro-panel of 270 goods prices drawn from major cities in 71 countries and 245 goods prices drawn from 13 major U.S. cities. We Þnd half-lives of deviations from the Law-of-One-Price for the average good is about 1 year; somewhat lower for U.S. cities and somewhat higher for cities in the OECD with LDC cities in between. This speed of adjustment is well below the concensus range of estimates of 3 to 5 years for purchasing power parity deviations yet consistent with plausible 'price-stickiness.' We further construct price indices using our micro data and Þnd that aggregation bias combined with small sample bias accounts for a large part of the difference between micro and macro estimates for the OECD.
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