Understanding Law-of-One-Price Deviations across Europe Before and After the Euro

Abstract

We use a panel of thousands of good-level prices before and after the euro in order to compare the determinants and understand the evolution of goods price dispersion across Europe during these two periods. We find that tradeability plays a substantially smaller role in lowering crosscountry dispersion after the adoption of the euro as compared to before, and that the role of non-traded inputs in raising price dispersion is also reduced after the euro. We then compare the overall and country-level distributions of law-of-one-price (LOP) deviations at the early and late part of our sample to inform us about the degree of integration across European economies before and after the euro. Our tests reveal that the distributions after the euro are significantly different than those before, consistent with a greater degree of integration. Utilizing our panel to trace the location of individual goods in the distribution of LOP deviations, we ask how the price advantage or disadvantage of individual economies evident in these price distributions has been shifting over time, and whether goods characteristics play a role for the persistence of these LOP deviations. LOP deviations for these goods are highly correlated, on average, over five or ten year horizons, but much less so over twenty-year or longer horizons. These correlations are greater for homogeneous as compared to differentiated goods, and vary across countries. Finally, for the great majority of these European economies and goods, price advantage is typically revealed to be more persistent than price disadvantage.