Europe Without Borders? The Effect of the Euro on Price Convergence

Abstract

Has the introduction of the Euro reduced the impact of national borders on cross-border market convergence across the Euro Area? This paper extends Engel and Rogers (1996) well known work on border effects to cities across Western Europe over the period 1995 to 2002. While cross-border prices across the Euro Area are still more volatile than within-country prices, the importance of the border has diminished since 1999. The impact of the common currency on the border effect varies by country size, with the largest decreases occurring between larger Euro countries. While cross-border price volatility has not changed between the UK and large Euro countries, volatility has actually increased between the small Euro countries and the UK. These results are consistent with the fact that exchange rates are more likely to adjust to price differentials between small countries than between large countries.