Regional Relative Price Disparities and Their Driving Forces

Abstract

(ProQuest: ... denotes formulae omitted.)I.INTRODUCTIONThis paper studies relative price level convergence by utilizing panels of major cities in Korea. While substantial research continues to evaluate price level disparities in international context, there have been relatively lack of successful empirical studies investigating the validity of purchasing power parity (PPP) within a single currency area. To gain further insight for the sources of considerable and persistent price level dispersion, we employ formal statistical techniques to test whether intranational price level differentials tend to shrink over time with a special emphasis on their heterogeneous transitional behavior. Our empirical analysis explores potential explanations for why there is substantial deviation from PPP or markedly slow convergence by considering disaggregated CPI data classified according to consumption expenditure in addition to extant factors that are attributable to the PPP deviations, such as transportation costs, income, and input prices.The importance of understanding both time-series and cross-sectional properties of price dispersion measures has been underscored by researchers as well as policymakers. Since PPP has been a key building block of most open-economy macroeconomic models as the link between exchange rate and relative price levels, empirical validity of PPP is a long-standing issue. Ever since Rogoff (1996) articulated the PPP puzzle, a large number of papers have studied price level convergence with international data and potential sources of PPP deviation or slow price level convergence.1 This has also brought about interest in testing convergence in relative city price within a country to better understand difference in prices across locations, Beck, Hubrich, and Marcellino (2009), Cecchetti, Mark, and Sonora (2002), Parsley and Wei (1996), and Sonora (2008), to name a few. Unlike international data, it may be reasonable to conjecture that major cities of a country share relatively similar characteristics, and thus relative price dispersion is unlikely to be substantial. However, the conclusion regarding long-run patterns of price disparities across cities is somewhat mixed, whereas PPP clearly is violated in the short run in those studies. Interestingly, some studies argue that price level convergence rates within a country are somewhat longer than those estimated with international data (Cecchetti, Mark, and Sonora, 2002).Despite the fact that the deviation from PPP is well documented in international data and even within a country, there has not been an extensive study rigorously investigating the possibility of PPP among major cities in Korea.2 This motivates us to examine the long-run behavior of relative price level dispersion with a special emphasis on heterogeneous transition dynamics of individual prices. In addition, with disaggregated CPI data, the paper scrutinizes dynamic patterns of price disparities for consumption expenditure categories classified according to purpose.3 Our research has primarily three goals. First, we investigate whether there exist persistent regional price level disparities, and, if so, assess the extent of deviations from PPP. In addition, their dynamic patterns are also examined. Second, and more importantly, this paper aims to provide a better understanding of main factors that drive substantial price level disparities across cities. Third, as overall price divergence does not necessarily exclude the possibility of club convergence, we explore whether there is a subgroup of cities that share similar aspects in terms of socioeconomic variables and exhibit price level convergence among the member cities.To draw attention to the importance of regional price level dispersion, we first document some salient features of intercity price differentials.4 Some basic descriptive statistics of price differential variability and mean absolute log price differential indicate that there is little evidence of price level convergence. …