Has the Euro increased international price elasticities?

Abstract

The introduction of the Euro has been accompanied by the hope that international competition between EMU member states would increase due to higher price transparency. This paper contributes to the literature by analyzing price elasticities in international trade flows between Germany and France and between Germany and the United Kingdom before and after the introduction of the Euro. Using disaggregated Eurostat trade statistics, we adopt a heterogeneous dynamic panel framework for the estimation of price elasticities. We suggest a Kalman-filter approach to control for unobservable quality changes which otherwise would bias estimates of price elasticities. We divide the complete sample, which ranges from 1995 to 2008, into two sub-samples and show that price elasticities in trade between EMU members did not change substantially after the introduction of the Euro. Hence, we do not find evidence for an increase in international price competition resulting from EMU.

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Notes

  1. 1.

    These effects have also been confirmed empirically, for example by Katics and Petersen (1994) and Chen et al. (2009).

  2. 2.

    This does only hold if there is at least a small degree of exchange rate pass-through such that prices actually change in case of exchange rate movements.

  3. 3.

    Frankel and Rose (1998), for example, have argued that the introduction of a single currency leads to a higher degree of international integration, meaning that the net benefit of a currency union compared to a flexible exchange rate regime is increased ex post after its introduction.

  4. 4.

    Instead, the common currency did rather promote investments due to lower real interest rates and lower capital costs (Boltho and Eichengreen 2008). For the larger member states, the savings in transaction costs were already a priori expected to amount only to a maximum of 0.2% of GDP (Commission of the European Communities 1990)

  5. 5.

    The Euro’s effect on price convergence has additionally been analyzed by Engel and Rogers (2004), Allington et al. (2005) and Rogers (2007). In this context, the fact that international trade especially between high-income countries is largely intra-industry in nature, i.e., consists of the exchange of differentiated goods, might be relevant. In a world of product differentiation, the hopes that higher price transparency in case of a common currency will lead to more arbitrage transactions and will thereby increase trade flows and price convergence are probably overstated, since due to brand loyalties and goods or services designed to specific customer needs, competition is not solely limited to prices (Posen 1999).

  6. 6.

    For an overview see Anderson and van Wincoop (2004), for example.

  7. 7.

    The literature has explored the impact of these variables on bilateral trade using gravity models, see Frankel (1997), Evenett and Keller (2002) and the seminal contribution by Linnemann (1966).

  8. 8.

    See, for example, Lütkepohl (2005).

  9. 9.

    See also Erkel-Rousse and Mizra (2002) for a discussion of unit values in the context of import price elasticity estimation.

  10. 10.

    These assumptions are necessary for identification because the pure structural VAR is just-identified leaving no degrees of freedom. Therefore additional parameters—like an additional shock variance – cannot be estimated.

  11. 11.

    Of course, nominal import shares and relative prices would also change in the same magnitude if quantity demanded would not react to changes in relative prices, i.e., if price elasticity of demand equals zero. Since in the Kalman filter estimation, such common changes in relative prices and import shares would not enter into price elasticity estimates, but into the unobservable quality variable, price elasticities could be over-estimated.

  12. 12.

    Price elasticities of demand in different product categories should depend on whether products are rather substitutes or compliments. The more products in a certain HS-group are substitutes, the higher price elasticities of demand should be.

  13. 13.

    To be more precise, we do not report the usual mean estimate but trimmed means. We have excluded the 2.5% highest estimates and the 2.5% lowest estimates of the HS6 categories because there are some extreme outliers. (We do not trim within each HS2 section.)

  14. 14.

    Elasticities higher than one are reported especially for more homogeneous sections like mineral fuels (section 27) or iron and steel (section 72), for example. Elasticities smaller than one are reported for more heterogeneous sections like pharmaceuticals (section 30) or machinery and mechanical appliances (section 84), see Electronic supplementary materials.

  15. 15.

    According to the SVAR estimations reported in the separate Electronic supplementary materials, price elasticities in German imports from France are above average in HS product groups 4 (Dairy produce, birds’ eggs, natural honey, edible products of animal origin) and 22 (Beverages, spirits and vinegar). These HS categories are only considered in German imports from France. In the other trade relations, their share is below 1%.

  16. 16.

    Estimation results with January 1999 as cutting point can be obtained on request.

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Acknowledgments

We thank Annika Klatt for excellent research assistance and Herbert Buscher, Toralf Pusch, and two anonymous referees for helpful comments on an earlier version of this paper.

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Correspondence to Oliver Holtemöller.

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Holtemöller, O., Zeddies, G. Has the Euro increased international price elasticities?. Empirica 40, 197–214 (2013). https://doi.org/10.1007/s10663-011-9182-3

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Keywords

  • European integration
  • Introduction of the Euro
  • Import price elasticity
  • Panel data
  • Kalman-filter
  • Structural vector autoregression

JEL Classification

  • F14
  • F15
  • F41
  • C32
  • C33