Border region panel evidence on PPP deviations

Abstract

This article examines prices for 32 identical menu items sold by restaurant franchises operating on both sides of the border between El Paso in the US and Ciudad Juárez in Mexico from July 1997 to June 2008. The relationship between Real Exchange Rate (RER) volatility and the degree of price convergence is examined within a panel data context. The city-pair and goods selected provide a unique experiment in which distance, tradability and industry considerations are set aside and the extent of RER volatility is the only factor to influence price convergence. We find nonmonotonic relationships between mean reversion and RER volatility: very fast adjustments for both low and high volatility panels of goods (between 1 and 2 months) and slower half-lives (between 3 and 4 months) at moderate levels of uncertainty. These figures are, however, substantially smaller than the 6 or 7 months reported in previous research for general US–Mexico goods, suggesting the very strong price convergence observed along the US–Mexican border.

Keywords:

• half-lives
• PPP
• real exchange rates
• USA–Mexico border region
• volatility

JEL Classification::

• F31
• M21

Acknowledgements

Econometric research assistance provided by Enedina Licerio and Teodulo Soto for the first author and by Tibebe Assefa for the second author.

Notes

¹ In the economic development area, there is a body of evidence linking volatility to economic growth. For example, Ramey and Ramey (1995) provide evidence that countries with highly volatile Gross Domestic Product (GDP) grow at slower paces. Aizenman and Marion (1999) further indicate that countries with highly volatile GDP also experience lower rates of private investment. A number of different factors can influence volatility, including geography, institutions and trade mix (Malik and Temple, 2009).

² The most likely interpretation of a deterministic trend involves the substantial changes in the relative prices of tradables versus nontradables. In Obstfeld (1993), the time trend in RERs could indicate differential in the productivity in growth of tradables versus nontradables.