Price convergence in the European Union

This paper assesses the progress in EU product market integration by analyzing price differentials in a multivariate framework for 22 industrialised economies and almost 200 product categrories. We model changes in bilateral price similarities as a function of initial bilateral similarity levels, bilateral trade intensities, the bilateral correlation between expenditure shares and various variables reflecting EU membership, product category, the tradability of the product and the presence of non-tariff barriers throughout 1985-1999. The results suggest that price structures within the EU are more similar than among other OECD countries, especially for energy products and consumer goods. After correcting for factors such as catchingup and trade intensities, prices in the EU have almost consistently converged faster than in the rest of the OECD. Finally, we find that the countries in the so-called D-Mark area have witnessed a significantly stronger tendency for prices to converge than countries which have had relatively higher exchange rate fluctuations. This gives some foundation to hopes that monetary union will promote price convergence.