Explaining the Border Effect: The Role of Exchange Rate Variability, Shipping costs, and Geography

Abstract

This paper exploits a three-dimensional panel data set of prices on 27 traded goods, over
88 quarters, across 96 cities in the US and Japan. We show that a simple average of
good-level real exchange rates tracks the nominal exchange rate well, suggesting strong
evidence of sticky prices. Focusing on dispersion in prices between city-pairs, we find that
crossing the US-Japan “Border” is equivalent to adding as much as 43,000 trillion miles to
the cross-country volatility of relative prices. We turn next to economic explanations for this
so-called border effect and to its dynamics. Distance, unit-shipping costs, and exchange rate
variability, collectively explain a substantial portion of the observed international market
segmentation. Relative wage variability, on the other hand, has little independent impact on
segmentation.

JEL classification : F30; F40; F15

Single copies of the article can be downloaded and printed for the reader’s personal research and study. Reprinted from the Journal of International Economics, vol.55, no.1, David C. Parsley and Shang-Jin Wei, “Explaining the Border Effect: the Role of Exchange Rate,” Pages 87-105, Copyright (2001), with permission from Elsevier Science.