Deviations from Purchasing Power Parity: Causes and Welfare Costs.

This paper explores deviations from short-run purchasing power parity (PPP) across European cities, attempting to expand research that document very large border effects. This study documents two very distinct types of border effects embedded in relative prices: the "real barriers effect", caused by various barriers to market integration and a sticky-consumer-price cum volatile exchange-rate effect. These border effects are shown to be important empirically, the second type especially so. The authors argue that the two effects are very different from each other and the first type of effect implies deadweight welfare losses. The second type of border effect could be eliminated with fixed exchange rates with welfare not necessarily being increased. This working paper can be found at the United States Federal Reserve Board's International Finance Discussion Papers. You can access it by going to http://www.federalreserve.gov/pubs/ifdp/.