If price levels are initially different across the euro area, convergence to a common level of prices would imply that inflation will be higher in countries where prices are initially low. Price level convergence thus provides a potential explanation for recent cross-country differences in European inflation, a worrisome development under the ECBs "one-size-fits-all" monetary policy. I present direct evidence on price level convergence in Europe, using a unique data set, and then investigate how much of the recent divergence of national inflation rates can be explained by price level convergence. I show that between 1990 and 1999 prices did become less dispersed in the euro area. Convergence is especially evident for traded goods, and more in the first half of the 1990s than the second half. By some measures, traded goods price dispersion across the euro area is now close to that across U.S. cities. Despite an ongoing process of convergence, deviations from the law of one price are large. Finally, I find a statistically-significant and robust negative relationship between the 1999 price level and 2000 inflation rate in Europe, and that the contribution of price level convergence to explaining inflation differentials is often quite important economically. Still, factors other than price convergence explain most of the crosscountry inflation differences. JEL classification: E31, F36, F41 Keywords: prices, economic integration, exchange rates, purchasing power parity, euro * Senior economist, International Finance Division, Board of Governors of the Federal Reserve System, Washington, D.C. 20551. 202-452-2873, John.h.Rogers@frb.gov. I would like to thank Jon Faust, Joe Gagnon, Mike Gilbert, Chris Gust, Dale Henderson, Gary Hufbauer, Jane Ihrig, Karen Johnson, Steve Kami...

We study the dynamics of good-by-good real exchange rates using a micro-panel of 270 goods prices across 90 international cities and 13 cities within the U.S., annually from 1990 to 2000. The picture of relative price adjustment that emerges from our analysis is that price adjustment is very rapid both across cities within countries and across cities of the world. In terms of persistence of Law-of-One-Price deviations, national borders appear not to matter. What national borders do matter for are the magnitudes of the long run deviations from the Law-of-One-Price. Across U.S. cities the deviations are economically small while across international cities the deviations are economically large. 1.

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Using consumer price indexes from cities in the U.S., Canada and Mexico, we estimate the "border effect" on U.S.-Mexican relative prices and find that it is nearly an order of magnitude larger than for U.S.-Canadian prices. However, during a very stable sub-period in Mexico (May 1988 to November 1994), the "width " of the U.S.-Mexican border falls dramatically and becomes approximately equal to the U.S.-Canadian border. We then show that when consideration is limited to cities lying

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Evidence from Italy Regional patterns of inflation persistence have received attention only at a very coarse level of territorial disaggregation, that of EMU member states. However economic disparities within EMU member states are an equally important policy issue. This paper considers a country with a large regional divide, i.e., Italy, at a fine level of territorial disaggregation (NUTS3). Our results show that economically backward regions display greater inflation persistence. Moreover, we show that higher persistence is linked to a lower degree of competitiveness in the retail sector. 2

Based on a broad set of regional aggregated and disaggregated consumer price index (CPI) data from major industrialized countries in Asia, North America and Europe we are examining the role that national borders play for goods market integration. In line with the existing literature we find that intra-national markets are better integrated than international market. Additionally, our results show that there is a large ’ocean ’ effect, i.e., inter-continental markets are significantly more segmented than intra-continental markets. To examine the impact of the establishment of the European Monetary Union (EMU) on integration, we are splitting our sample in a pre-EMU and EMU sample. We find that border effects across EMU countries reduce by about 80 % to 90 % after 1999 whereas border estimates across non-EMU countries have basically not changed. Since globally effective factors have affected all countries in our sample similarly and major integration efforts across EMU countries were made before 1999, we suggest that most of the reduction in EMU border estimates has been ’nominal’. Panel unit root evidence shows that the observed large differences in integration across intra- and inter-continental markets remain valid in the longrun. This finding implies that real factors are responsible for the documented segmentations across our sample countries.

Following a policy rule mechanically when operating monetary policy is neither realistic nor practical. Nevertheless, monetary policy rules have received a great deal of attention in recent macroeconomic research. The paper focuses on a famous interest rate rule, namely the Taylor Rule, to show that the rule parameters are robust to most of the output gap measures and the specifications considered, i.e. the inflation coefficient is above unity and the output gap coefficient is positive. The estimated rule is shown to track the actual policy performance during the EMU period remarkably well. In addition, the estimated rule is used as an indicator of macroeconomic convergence in the union and it is demonstrated that the optimal EMU rate has not been in accordance with domestic conditions in certain countries.

The law of one price, or purchasing power parity in its aggregate form, provides a cornerstone for much of international economics. Not too surprisingly, its empirical validity has attracted strong interest. The consensus view has shifted over time; while early studies tended to reject PPP, the availability of longer time series and advances in econometric methodology have recently tilted the balance of evidence in favour of

This paper investigates the ability of a region participating in a currency union to a¤ect its in‡ation di¤erential with respect to the union through …scal policy. We study the interaction between regional …scal policy and in‡ation di¤erentials in a ‡exibleprice, two-region model with both traded and nontraded goods. For symmetric regions, changes in one region’s tax rule that decrease the volatility of its in‡ation di¤erential also decrease the volatility of its output. The decrease in the volatility of the in‡ation di¤erential is brought about by an increase in the volatility of tax rates. The e¤ect of the tax rule on output volatility – but not in‡ation volatility – depends on country size. For a small country lower volatility of in‡ation di¤erentials is associated with higher volatility of output. This relationship results from the fact that small countries are more open, and hence there is a greater role for traded goods productivity shocks.